Article 5 - PERMANENT ESTABLISHMENT

This Article defines the term "permanent establishment." This definition is relevant under several articles of the Convention. The existence of a permanent establishment in a Contracting State is necessary under Article 7 (Business profits) for the taxation by that State of the business profits of a resident of the other Contracting State. Since the term "fixed base" in Article 14 (Independent personal services) is understood by reference to the definition of "permanent establishment," this Article is also relevant for purposes of Article 14. 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 that the recipient has in the source State.

This Article follows closely both the OECD Model provisions

and recent U.S. treaties. The protocol to the prior Convention contains a similar definition of "permanent establishment".

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 the business of an enterprise is wholly or partly carried on.

Paragraph 2 contains a list of fixed places of business that will constitute a permanent establishment. The list is illustra­ tive and non-exhaustive. According to paragraph 2, the term permanent establishment includes a place of management, a branch, an office, a factory, a workshop, and a mine, oil or gas well, quarry or other place of extraction of natural resources.

Paragraph 3 provides rules to determine when a building site or a construction or installation project constitutes a permanent establishment. Only if the site, project, etc. lasts for more than twelve months does it constitute a permanent establishment. The twelve-month test applies separately to each individual site or project. The twelve-month period begins when work (including

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preparatory work carried on by the enterprise) physically begins in a Contracting State. A series of contracts or projects that are interdependent both commercially and geographically are to be treated as a single project for purposes of applying the twelve-month threshold test. For example, the construction of a housing development would be considered a single project even if each house in the development is constructed for a different purchaser. If the twelve-month threshold is exceeded, the site or project constitutes a permanent establishment as of the first day that the work in that State began. This interpretation of the Article is based on the Commentaries to paragraph 3 of Article 5 of the OECD Model, which contains language almost identical to that in the Convention. This interpretation, therefore, constitutes the generally accepted international interpretation of the language in paragraph 3 of Article 5 of the Convention.

In addition, installations, drilling rigs, or ships operating offshore to explore for or exploit natural resources are considered permanent establishments only if their use exceeds twelve months. Supply ships are not considered ships used to explore for or exploit natural resources. Natural resources do not include fish.

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 activities that may be carried on through a fixed place of business, but that will not give rise to a permanent establishment. The use of facilities solely to store, display or deliver merchandise belonging to an enterprise will not constitute a permanent establishment of that enterprise. The maintenance of a stock of goods belonging to an enterprise solely for the purpose of storage, display or delivery, or solely for the purpose of processing by another enterprise will not give rise to a permanent establishment of the first-mentioned enterprise. The maintenance of a fixed place of business solely for the purchases goods or merchandise, or for activities that have a preparatory or auxiliary character for the enterprise, such as advertising or the supply of information and scientific activities, will not constitute a permanent establishment of the enterprise. Finally, a combination of these activities will not give rise to a permanent establishment.

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

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Under paragraph 6, an enterprise will not be deemed to have a permanent establishment in a Contracting State merely because it carries on business in that State through an independent agent, including a broker or general commission agent, if the agent is acting in the ordinary course of its 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 of whether or not a permanent establishment exists will be made solely on the basis of the factors described in paragraphs 1 through 6 of the Article. Whether or not 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 companies.