Permanent establishment (PE) is a critical concept in international tax law that determines the taxable presence of a foreign entity in a country. It plays a crucial role in allocating taxing rights between countries and preventing double taxation.
As has been accepted internationally and under the OECD framework that the country, where the income is generated and economic activities take place, has the right to levy tax on such income which can be attributed to be arising in that country. In this context, countries often would like to levy tax on the profits that any non-resident may earn in that country. While, there is not much confusion as to the tax liability when a non-resident formally sets up an entity in the country which is then usually treated at par with the other domestic owned entities inviting same tax treatment (the exception could be in terms of regulations under Place of effective management which may liable the entity to be taxed in the state where the Place of effective management lies). The challenge lies where the non-resident does not formally set up or register entity in the country while still carrying on the business in the country and deriving income in the country.
This situation has led to the evolvement of the concept of Permanent Establishment (“PE”) under the International taxation parlance. A country would usually have provisions under the domestic tax laws for taxing profits of a non-resident which can be attributed to presence of Permanent Establishment in the country.
Originally, the concept involved taxing the income, as the name suggest, which can be attributed to “Permanent Establishment” meaning where the non-resident had some kind of presence in the country through physical establishment but over the years and with rapid digitalization, the concept is undergoing a change and a non-resident may become liable to tax even without physical presence.
Under the “Organisation for Economic Co-operation and Development” (OECD) model tax convention, a Permanent Establishment (PE) is broadly defined as a fixed place of business through which the business of an enterprise is wholly or partly conducted. The business profits of a foreign enterprise are only taxable in a state if the enterprise has a PE in that state.
In the context of UAE Corporate Tax, the provision related to PE are based on the OECD model. Article 12(3) of the Federal Decree Law No. 47 of 2022 on the Taxation of Corporations and Businesses provides that a Non-Resident Person is subject to Corporate Tax on the taxable income that is attributable to the PE of the Non-Resident Person in the UAE. Article 14 further defines three instances for presence of Permanent Establishment in the UAE as under:
1. PRESENCE OF FIXED OR PERMANENT PLACE:
Presence of fixed or permanent place in the UAE through which the business of the non-resident is conducted wholly or partially. The presence of fixed place is elaborated in Article 14(2) by way of an inclusive definition including presence of a place of management, a branch, an office, a factory, a workshop, mine or other installation or structure, a project site lasting more than 6 months etc.
Presence of fixed or permanent place of business in the UAE has to be evaluated on the basis of the factual position and in line with the guidance from OECD commentary and also guidance issued by the FTA. Accordingly, in line with the Corporate Tax guide on Non-Resident Persons issued by FTA in October 2023, following factors must be determined to evaluate presence of fixed or permanent place of business of a Non-Resident Person:
· The Non-Resident Person must have a “place of business” in the UAE which could include a facility such as office, a work location, premises or, in certain instances, machinery or equipment, which is used by the Non-Resident Person to carry on its business in the UAE on a regular or recurrent basis (referred to as “Place of Business test”).
· The Place of Business must be “fixed” i.e. it must be established at a distinct place with a certain degree of permanence (referred to as “Permanence test”). A case-by-case evaluation needs to be made considering all relevant factors but an aggregate period of more than 6 months (even if not continuous), in the relevant 12 consecutive months, will typically indicate permanence.
· The place of Business must be at the disposal of the Non-Resident person. The mere presence at a particular location does not necessarily mean that the location is at its “disposal”. The Non-Resident Person must have the right or effective power to use such place of Business (referred to as the “Disposal Test”).
· The activities performed by the Non-Resident Person at such place of Business must be core income generating activities and not of a preparatory or auxiliary nature ( referred to as the “Business Activity Test”).
“Preparatory” activities are those activities which precede commencement of core Business Activities and support the core Business Activities.
“Auxiliary” activities are those which aid or support the core Business function, without being part of the essential and significant part of the activity of the enterprise. They are secondary to the main or general functions of the enterprise which realise profits.
Article 14(3) of the UAE Corporate Law provides for the list of activities that will constitute as preparatory or auxiliary where merely presence of fixed or permanent place will not constitute presence of PE of a Non-Resident Person if it is solely used for the following purposes:
i. Storing, displaying or delivering of goods or merchandise belonging to that Person.
ii. Keeping a stock of goods or merchandise belonging to that Person for the sole purpose of processing by another Person.
iii. Purchasing goods or merchandise or collecting information for the Non-Resident Person.
iv. Conducting any other activity of a preparatory or auxiliary nature for the Non- Resident Person.
v. Conducting any combination of the above listed activities, provided that the overall activity is of a preparatory or auxiliary nature.
2. DEPENDENT AGENCY PERMANENT ESTABLISHMENT:
Article 14(2) of the UAE Corporate Tax law further provides that presence of a Person in the UAE who has the authority and habitually exercises the authority to conduct a business or business activity in the UAE on behalf of Non-Resident shall constitute PE of the Non-Resident.
Under this category, a dependent agent can constitute presence of PE for the Non-Resident. A dependent agent is a person who is both economically and legally dependent on a non-resident entity. If the dependent agent has and habitually exercises the authority to conclude contracts in the name of the non-resident entity, or negotiate the critical elements of such contracts without material modification by the non-resident, a PE may be deemed to exist.
A Person would create an agency PE for a Non-Resident Person if such Person, on a regular basis:
• concludes contracts in the UAE on behalf of a Non-Resident Person; or
• negotiates contracts in the UAE on behalf of a Non-Resident Person and such contracts are concluded by the Non-Resident Person without any material modification to the terms of the contracts.
The conclusion/negotiation of contracts by such Person must take place repeatedly and not merely in isolated cases, for it to be habitual and thus, constitute a PE for the Non-Resident Person.
An Agent’s actions should be binding on the Non-Resident Person vis-à-vis the end customer, and it cannot be said to be acting on behalf of a Non-Resident Person if the Non-Resident Person is not bound by the actions performed by such Agent.
It is immaterial whether the contracts are concluded in the name of the Non-Resident Person or such other Person who is acting on behalf of the Non-Resident Person. This means that even commissionaire or undisclosed principal arrangements can trigger a PE in the UAE for a Non-Resident Person.
In general terms, a commissionaire arrangement refers to an arrangement whereby a Person sells products in its own name but on behalf of another (Non-Resident) Person (who is the owner of these products). In theory, the commissionaire does not usually bind the principal and the customer cannot sue the Non-Resident Person, as there is no contractual relationship between the Non-Resident Person and the customer.
However, in substance, the obligation to perform is on the owner of the goods (i.e. Non-Resident Person) who sells directly to the customer.
To ensure commissionaire arrangements are not used to avoid the creation of a PE by the Non-Resident Person, emphasis is placed on substance over form. Therefore, where the activities of a Person/commissionaire bind the Non-Resident Person to perform activities, this would trigger a PE, even if the contracts are not in the name of the Non-Resident Person.
This is in line with the amendments made under the Base Erosion Profit Shifting (BEPS) project by the OECD to counter artificial avoidance of existence of PE.
3. NEXUS WITH THE UAE
Article 14(3) further provides for existence of the Non-Resident has any other form of nexus with the UAE as may be determined by the Cabinet decision. So far no cabinet decision has been issued in relation to provisions under Article 14(3) for constituting Non-resident person to be having PE in UAE in relation to nexus with the UAE. However, a non-resident juridical person has been subjected to corporate tax in the UAE having nexus with the UAE by way of owning real estate in the UAE.
In view of the provisions under the UAE Corporate Tax for taxing Non-Resident due to existence of PE in the UAE, it is important that Non-Resident person dealing in UAE or having any nexus or set up in UAE to carry out in depth analysis if any activity or set up or arrangement in UAE may lead to existence of PE in UAE and make Non-Resident person liable for UAE Corporate Tax. An analysis of whether a Non-Resident Person has a PE in the UAE is a fact and context specific exercise.
Additionally, even if a Non-Resident Person does not have a PE in the UAE, it should consider if it has nexus in the UAE, as this would make it subject to Corporate Tax in the UAE.
Additionally, provisions of the Corporate Tax Law will have to be read with the relevant Double Taxation Agreement (where available and effective) to determine the existence of a PE in the UAE. To the extent the provisions of a Double Taxation Agreement are inconsistent with the Corporate Tax Law, the Double Taxation Agreement provisions will prevail.
Article LinkedIn Link – https://www.linkedin.com/pulse/permanent-establishment-context-uae-corporate-2zngf/