Permanent Establishment (PE)
Permanent establishment is the threshold that determines whether a country can tax a foreign company's business profits. Without a PE, business profits are taxable only in the company's country of residence. With a PE, the source country can tax the profits attributable to that establishment.
Why PE Matters
A German software company sells products to US customers through its website. Without a PE in the US, the company's profits are taxed only in Germany. If the company opens a US office, hires US employees, or has agents concluding contracts in the US, it creates a PE — and the US can tax the profits attributable to that office.
PE is defined in Article 5 of both the OECD and UN Model Tax Conventions, and in virtually every bilateral treaty.
What Creates a PE
Fixed Place of Business
The core definition: a PE exists when there is a fixed place of business through which the business of an enterprise is wholly or partly carried on. This includes:
The place must be fixed (not temporary) and the business must be carried on through it (not merely stored there).
Construction Sites
A building site or construction project constitutes a PE if it lasts longer than a threshold period:
| Model | Threshold |
|---|---|
| OECD Model | 12 months |
| UN Model | 6 months |
| Actual treaties | Varies (6-12 months) |
Dependent Agents
A PE can also be created by a person (agent) who:
This was significantly expanded by the OECD's BEPS Action 7 (2015), which closed loopholes where companies used commissionnaire arrangements to avoid PE status.
Service PE (UN Model Only)
The UN Model includes a service PE provision: a company creates a PE if it furnishes services in the source country for more than 183 days in any 12-month period. This is not in the OECD Model but appears in many treaties with developing countries.
What Does Not Create a PE
Article 5 explicitly excludes certain activities:
However, the BEPS amendments narrowed these exclusions. Under the updated OECD Model, each activity must be genuinely preparatory or auxiliary — a warehouse that is integral to the company's delivery operation may no longer qualify for the exclusion.
PE and Withholding Tax
PE and withholding tax are separate concepts that apply to different income types:
| Income Type | Mechanism | Treaty Article |
|---|---|---|
| Business profits | PE test | Art. 7 |
| Dividends | Withholding tax | Art. 10 |
| Interest | Withholding tax | Art. 11 |
| Royalties | Withholding tax | Art. 12 |
Digital Economy Challenges
The rise of digital business models has created significant PE challenges. A company can generate substantial revenue from a country's customers without any physical presence there. This is the central issue behind the OECD's Pillar One proposals, which would allocate taxing rights based on revenue rather than physical presence.
Some countries have unilaterally introduced Digital Services Taxes (DSTs) to capture revenue from digital companies that fall below PE thresholds.