Recent developments, such as the Tax Cuts & Jobs Act (TCJA) and the OECD’s Base Erosion and Profits Shifting (BEPS) initiative, have forced multinational businesses to re-evaluate global strategies and the tax impact of doing business abroad. Navigating the risk of a permanent establishment remains among the most important international tax risks.
While a nonresident alien or foreign corporation engaged in a trade or business in the United States is generally subject to taxation on its net taxable income that is effectively connected with the conduct of the U.S. trade or business, the rules are different (or at least, can be) when a resident of a treaty country conducts the business. Where a tax treaty is applicable, the concept of a permanent establishment—and whether income is attributable to that permanent establishment—replaces the concept of effectively connected income as the governing standard.
Generally, a business enterprise that is a resident in one treaty country will only be taxed on its business profits by the other country if it carries on its business operations through a permanent establishment. Where a permanent establishment exists, the business enterprise is potentially subject to tax by the host country to the extent of its profits that are allocable to the permanent establishment.
Whether a permanent establishment exists generally depends upon whether the business conducts activities that are attributable to a fixed place of business in the treaty country. Some categories of locations and activities give rise to a “per se” permanent establishment. A business may also have a deemed permanent establishment—regardless of whether it has a fixed place of business in the treaty country—as a result of its contractual activities.
What is a Permanent Establishment?
As used in the U.S. model treaty, a permanent establishment is a fixed place of business through which the taxpayer’s business is wholly or partly carried on.
Generally, the place of business must be “fixed” in the sense of a particular building or physical location through which the enterprise conducts its business. It must, however, be foreseeable that the enterprise’s use of the building or other physical location will be more than temporary.
A permanent establishment includes (though is not at all limited to) the following examples:
- 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
What is a “Branch”?
The Tax Court has addressed the meaning of the term “branch,” at least for purposes of section 954(d)(d), providing that it should be given its customary meaning as a “[d]ivision, office, or other unit of business located at a different location from [the] main office or headquarters” or as an office in a different location than the parent company. If the taxpayer maintains a branch in a treaty county, it has a PE in that county.
Foreign Agents and Permanent Establishments
A foreign enterprise will also be considered to have a U.S. permanent establishment as a result of activities undertaken on its behalf by a dependent agent who has and habitually exercises in the United States an authority to conclude relevant contracts that are binding on the foreign enterprise. A foreign enterprise will not, however, be deemed to have a permanent establishment in the United States merely because it carries on business in the United States through a broker, general commission agent, or any other agent of an independent status, provided that such person is acting in the ordinary course of his business as an independent agent.
Activities that are Generally Not a Permanent Establishment
U.S. tax treaties typically provide that several common categories of activities will generally not be classified as a “permanent establishment.” Those categories generally include the following:
- the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise;
- the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery;
- the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;
- the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or of collecting information, for the enterprise;
- the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character;
- the maintenance of a fixed place of business solely for any combination of the activities mentioned in subparagraphs (a) through (e) of this paragraph, provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character.
The Impact of a Permanent Establishment
A foreign enterprise conducting business in the United States through a permanent establishment will, under a tax treaty, be taxed in the United States on its profits attributable to that permanent establishment.
This treatment is consistent across the OECD model treaty, the U.N. model treaty, and the U.S. model treaty:
- The OECD model tax treaty provides that the profits of an enterprise “shall be taxable” only in the country of which the enterprise is a national “unless the enterprise carries on business in [another country] through a permanent establishment situated therein.”
- The UN Model Treaty similarly provides that the profits of an enterprise are taxable in a country only if “the enterprise carries on business in [that country] through a permanent establishment situated therein.” 
- The U.S. Model Tax Treaty contains similar provisions barring taxation absent a permanent establishment. 
 OECD, Model Tax Convention on Income and on Capital: Condensed Version 2017, art. 7(1).
 UN, Model Double Taxation Convention Between Developed and Developing Countries, art. 7(1).
 Compare United States Model Income Tax Convention, art. 7 (“Profits of an enterprise of a Contracting State shall be taxable only in that Contracting State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein.”) with U.S.-UK Tax Treaty, art. 7 (“The business profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the business profits of the enterprise may be taxed in the other State but only so much of them as are attributable to that permanent establishment.”).