Article 5. PERMANENT ESTABLISHMENT

This Article defines the term "permanent establishment," which is relevant to several articles of the Convention. The current or former existence of a permanent establishment in a

Contracting State is necessary under Article 6 (Business Profits) for that State to tax the business profits of a resident of the other Contracting State. Articles 10, 11 and 12 (dealing with dividends, interest, and royalties, respectively) provide for reduced rates of tax at source on payments of these items of income to a resident of the other State only when the income is not attributable to a permanent establishment or fixed base which the recipient has or had in the source State; if the income is attributable to a permanent establishment, Article 6 (Business Profits) applies (and if the income is attributable to a fixed base, Article 14 (Independent Personal Services) applies).

This Article is similar in most respects to the corresponding articles of the OECD Model and conforms with U.S. treaty policy. It does, however, depart from that Model and those policies in certain respects.

Paragraph 1 provides the basic definition of the term "permanent establishment." As used in the Convention, the term means a fixed place of business through which a resident of one Contracting State carries on business activities in the other Contracting State. It is not necessary that the resident be a legal entity. Point 1 of the Protocol makes clear that it is also unnecessary that the fixed place of business be owned by the resident. In the case of an individual, Article 14 (Independent Personal Services) uses the concept of a "fixed base" rather than a "permanent establishment," but the two concepts are considered to be parallel.

Paragraph 2 contains a list of examples of fixed places of business that constitute permanent establishments: a place of management, a branch, an office, a factory, a workshop, and a mine, well, quarry or other place of extraction of natural resources. The use of singular nouns in this illustrative list is not meant to imply that each such place necessarily represents a separate permanent establishment. In the case of mines or wells, for example, several such places of business could constitute a single permanent establishment if the project is a whole commercially and geographically (see the following discussion under construction sites and drilling operations). Mines, wells, or quarries are examples of fixed places that may not be owned by the resident of the other State but that can nonetheless form a permanent establishment of that resident.

Paragraph 3 adds that a construction site, installation or assembly project, or an installation or drilling rig (onshore or offshore) or ship used to explore for or exploit natural resources also constitutes a permanent establishment, but only if it lasts more than 12 months. This is the period provided for in the OECD Model, and it is consistent with U.S. treaty policy. The 12-month test applies separately to each individual site or project. A series of contracts or projects that are

interdependent both commercially and geographically is to be treated as a single project. For example, the construction of a housing development would be considered a single project even if each house were constructed for a different purchaser. Similarly, the drilling of several wells within the same geographic area and as part of the same commercial operation will be considered a single permanent establishment.

The 12-month period begins when work (including preparatory work carried on by the resident) physically begins in a Contracting State. A site should not be regarded as ceasing to exist when work is temporarily discontinued. If the 12-month threshold is exceeded, the site or project constitutes a permanent establishment from the first day.

The foregoing interpretation of paragraph 3 is based on the Commentaries to paragraph 3 of Article 5 of the OECD Model, which constitutes the generally accepted international interpretation of the language in paragraph 3 of Article 5 of the Convention.

The furnishing of supervisory services may give rise to a permanent establishment under paragraph 3. Supervisory services that do not themselves last for more than 12 months may nonetheless be an interrelated part of a construction project; in that case, the period of time during which supervisory services were carried on will be added to the time during which the construction is carried on for purposes of determining whether the building contractor meets the 12-month test. Supervisory services may be performed by the building contractor or by another enterprise (e .q ., a subcontractor). If the services are performed by another enterprise, then such services may also constitute an independent permanent establishment of that other enterprise if they continue for more than 12 months. The addition of the reference to supervisory services generally is consistent with the OECD Model. The commentary to paragraph 3 of Article 5 of the OECD Model points out that activities of planning and supervision, as well as activities of subcontractors, are taken into account in determining whether the general contractor has a permanent establishment.

The furnishing of services, including consultancy services, by a resident of one Contracting State through employees or other personnel in the other State will give rise to a permanent establishment if such services last for more than 12 months. As is true with respect to the type of permanent establishment created through a construction project, time spent performing services with respect to the same or related service projects will be aggregated for purposes of applying this 12-month threshold. Although the preferred U.S. treaty policy is that services do not give rise to a permanent establishment unless performed through a fixed place of business or by a dependent agent, the United States has agreed to similar provisions in

other treaties with developing countries (for example, India and Indonesia and, more recently, the Czech Republic and the Slovak Republic). Moreover, the 12-month threshold agreed to in this Convention is much longer than the 183 days that the United States has accepted in these other treaties. The U.N. Model also contains a shorter period of an aggregate of 6 months in a 12 month period.

Paragraph 4 contains exceptions to the general rule of paragraph 1 that a fixed place of business through which a business is carried on constitutes a permanent establishment. The paragraph lists a number of activities that may be carried on through a fixed place of business but that, nevertheless, will not give rise to a permanent establishment. The use of facilities solely to store, display or deliver merchandise belonging to a resident will not constitute a permanent establishment of that resident. The maintenance of a stock of goods belonging to a resident solely for the purpose of storage, display or delivery, or solely for the purpose of processing by another resident will not give rise to a permanent establishment of the resident. The maintenance of a fixed place of business solely for purchasing goods or collecting information for the resident, or for carrying out any other activity of a preparatory or auxiliary character for the resident, such as advertising, the supplying of information, or the conduct of certain research activities, will not constitute a permanent establishment of the resident.

A combination of the activities described in paragraph 4 will not give rise to a permanent establishment.

Paragraphs 5 and 6 specify when the use of an agent will constitute a permanent establishment. Under paragraph 5, a dependent agent of a resident of one State will be deemed to be a permanent establishment of that resident in the other State if the agent has and habitually exercises an authority to conclude contracts in the name of the resident. If, however, the agent's activities are limited to those activities specified in paragraph 4 that would not constitute a permanent establishment if carried on directly by the resident through a fixed place of business, the agent will not be a permanent establishment of the resident.

Under paragraph 6, a resident of one State will not be deemed to have a permanent establishment in the other State merely because it carries on business in the other State through an independent agent, including a broker or general commission agent, as long as the agent is acting in the ordinary course of his business.

Paragraph 7 clarifies that a company that is a resident of a Contracting State will not be deemed to have a permanent establishment in the other Contracting State merely because it

controls, or is controlled by, a company that is a resident of that other Contracting State or that carries on business in that other Contracting State. The determination whether a permanent establishment exists will be made solely on the basis of the factors described in paragraphs 1 through 6 of the Article. Whether a company is a permanent establishment of a related company, therefore, is based solely on those factors and not on the ownership or control relationship between the two.