Optimizing Permanent Establishment Clause for Resource Rich Countries
Double Taxation Agreements (DTAs) are bilateral tax treaties that are designed to reduce the negative impact of double taxation through the allocation of taxing rights to the State of residence (i.e. where the company has its base) and to the State of source (i.e. where the taxable operations takes place). The allocation of the rights to tax business profits of non-resident entities’ operations depends on whether these operations can constitute a “Permanent Establishment” (PE) according to the definition included in each DTA. If non-resident entities fulfill the criteria established in this PE definition, taxation is due at the source State. On the contrary, if non-resident entities fall outside of the scope of this definition, the residence State obtains these rights. DTAs can therefore result in source States losing significant tax revenue from operations of non-residents (unless such operations are conducted under a PE).
Loosely defining the PE without due regard for the risk of loopholes might encourage companies to structure their investments in order to avoid fulfilling the criteria of the PE definition and thus avoid taxation at source. For the purpose of extractive industries, these tax avoidance structures normally involve bypassing the time threshold that triggers a PE (by splitting long term contracts into short term contracts), and/or structuring and dividing contracts to enable them to be considered of preparatory or auxiliary nature, thus fitting into then general exclusions of PE that exist in most DTAs (fragmentation of activities and/or misuse/abuse of specific activity exemptions);
The UN and OECD Model DTAs – normally used as basis for DTAs – are not aimed at covering the specific characteristics of extractive industries. Resource rich States should thus aim to include specific clauses that cover these issues; after explaining the various options to optimize taxing rights related to PE in the context of extractives, CCSI’s brief presents a sample PE clause to that effect.