The significance of a permanent establishment in international tax law
Corporate profits are taxed in full in the state in which the company’s registered office is located. This basic principle also applies in cases where the company has international operations.
However, there are a few exceptions to this principle, specifically where the company has a permanent establishment in another state. In this case the state in which the permanent establishment is located has the right to tax the profits from the permanent establishment. The state in which the company is headquartered taxes either only the residual profits of a company (exemption method with a progression proviso) or the total profits subject to a deduction of the taxes levied at the place of the permanent establishment (credit method). However, this deduction cannot exceed the amount of tax that would be levied on the profits of the permanent establishment under Austrian stipulations (maximum credit amount).
The question of whether a permanent establishment exists in another state is therefore decisive for the attribution of taxation rights to corporate profits.
What constitutes a permanent establishment?
A permanent establishment is a fixed place of business through which the business of an enterprise is wholly or partly carried on.
For a permanent establishment to exist, therefore, the following criteria must be met:
- A “place of business”, i.e. power of disposal over certain (owned or let) facilities, premises or mechanical apparatus. For instance, permanently installed vending machines, market stalls etc. also count as places of business. Working premises provided by foreign clients may also constitute a permanent establishment.
- The place of business must be “fixed”, i.e. it must be located at a specific site for a specific duration (which is why for instance booths at trade fairs are not deemed permanent establishments).
- The company must carry out its commercial activity at this fixed place of business.
The term “permanent establishment” therefore covers in particular
- a place of management
- a branch
- an office
- a factory
- a workshop and
- a mine, an oil or gas well, a quarry or another place of extraction of natural resources.
Despite being fixed places of business, international tax law does not recognise places that satisfy exclusively preparatory or auxiliary functions (e.g. exclusive distribution warehouses, showrooms etc.) as permanent establishments.
A permanent establishment comes into being as soon as the company starts to carry out its activity through a fixed place of business. The point at time at which the fixed place of business was set up is not material.
The permanent establishment comes to an end when the power of disposal over the fixed place of business is relinquished or the commercial activity ceased. However, a temporary interruption of operations does not count as a shutdown. The permanent establishment is usually deemed at an end where it becomes subject to a lease.
Building sites or construction or assembly projects
In international tax law building sites or construction or assembly projects also count as permanent establishments if their duration exceeds twelve months.
The expression “building sites or construction or assembly projects” relates not only to the construction of buildings, but also of roads, bridges and canals, the laying of pipelines as well as earthworks and excavations. This also includes the planning and monitoring of the construction of the building if performed by the building contractor.
The twelve-month rule applies to each individual building site or construction or assembly project. By way of exception, construction projects based on different contracts should be counted together if they form a coherent whole in economic and geographical terms (e.g. the construction of terraced houses, the laying of pipelines).
The construction project starts with the preparatory negotiations (e.g. the establishment of a construction planning office) and ends once the work is completed or ultimately discontinued. Temporary interruptions to work due to for example effects of weather, technical faults, shortages of material etc. will be included in the calculation of the period.
If a general contractor subcontracts some of the contract to subcontractors, the times that the subcontractor is present on the construction site will be attributed to the general contractor. The subcontractor itself will be deemed to have a permanent establishment on the construction site if its activities there exceed twelve months.
“Representative’s permanent establishment”
A permanent establishment of a company may also be established by dependent representatives (e.g. employees). However, the employment of dependent representatives will only give rise to a permanent establishment if they have the authorisation to enter into contracts in the name of the company and also exercise this authorisation as a matter of course (authority to enter into contracts).
The authority to enter into contracts must apply to contracts that constitute the company’s actual commercial activity. An authority to enter into contracts will not be deemed given if the contracts only become valid once they have been approved by the company.
Ascertainment of profits
The profits of the permanent establishment must be ascertained taking into account the earnings and outlays attributable to the permanent establishment (income and expenditure). The profit must be ascertained both under the rules of the state of the permanent establishment as well as the rules of the state in which the company has its registered office.
(Source: WKO Die Betriebsstätte im internationalen Steuerrecht, last revised 1 January 2017)
If you have any questions, please do not hesitate to contact us.
Vienna, June 2017