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 7 (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 in the source State; if the income is or was attributable to a permanent establishment, Article 7 (Business Profits) applies (and if the income is or was attributable to a fixed base, Article 14 (Independent Personal Services) applies).

This Article is similar in most respects to the corresponding Article of the OECD Model.

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 either wholly or in part carries on business activities in the other Contracting State. It is not necessary that the resident be a legal entity. 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 which constitute a permanent establishment: 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.

Paragraph 3 adds that a construction site, installation or assembly project, or an installation or drilling rig or ship used to explore for or exploit natural resources also constitutes a

permanent establishment, but only if it lasts more than 6 months. Although shorter than the period provided in some recent treaties, such as the treaty with the Russian Federation, this period is longer than the period provided in some other treaties with less-developed states, such as the 120 day period provided in the tax treaty with India. This period therefore may be considered to be consistent with recent U.S. treaty policy in treaties with developing countries. Further, pursuant to Article 29 (Entry into Force), during the first taxable year in which the Convention is in effect, a taxpayer may claim the benefit of the longer period provided in the 1973 Convention (but only beyond the end of that first taxable year to the extent consistent with the six month period provided in the Convention).

The 6-month test applies separately to each individual site or project. The period begins when work (including preparatory work carried on by the resident) physically begins in a Contracting State. 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 is constructed for a different purchaser. If the 6month threshold is exceeded, the site or project constitutes a permanent establishment from its first day. This interpretation of the Article is based on the Commentaries to paragraph 3 of Article 5 of the OECD Model, which constitute the generally . accepted international interpretation of the language in paragraph 3 of Article 5 of the Convention. Drilling rigs, both onshore and offshore, are covered by this rule, and must, therefore, be present in a Contracting State for 6 months to constitute a permanent establishment.

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 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 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 supply of information, or 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 where a permanent establishment does not otherwise exist under paragraphs 1 through 4. 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, his activities are limited to those activities specified in paragraph 4 that would not constitute a permanent establishment if carried on directly by the enterprise through a fixed place of business, the agent will not be a permanent establishment of the enterprise.

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 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 of 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 companies.