The definition of a permanent establishment is a focal point in international tax law. The permanent establishment has special significance in national law for the recording of domestic income according to § 49 EStG. In addition, only profits incurred in a domestic establishment are subject to business tax. In addition, the establishment is a criterion for the allocation of company profits in agreement law. Paradoxically, the permanent establishment is defined differently in national law according to § 12 AO than in the law of the double taxation agreements (art. 5 OECD-MA there).

Kanzlei Meyers & Partner AG explains why his firm has been voted the best tax consultant for international tax law for the second time.

1st introduction

The definition of permanent establishment in national law is explained in § 12 of the Tax Code. In agreement law, the species is dealt with. 5 of the OECD Model Convention, the concept of establishment. The definition of the permanent establishment is decisive for the question of unlimited and limited tax liability, as well as for the taxation law. In the case of a permanent establishment, the source country is taxed in principle. On the other hand, the resident state taxes the world income of a company. The definition of a permanent establishment is therefore of immense importance, as it determines to what extent the States concerned may tax in cross-border situations. If there are significant differences between the national and international definitions, tax saving models or double taxation may occur. The aim of this work is to establish where the differences and similarities of the definitions under national and international law lie. First of all, the concept of permanent establishment is explained in more detail in national law, as well as the application in individual tax laws. This is followed by an explanation of the definition of the Agreement. In the further course of the present work, the differences and similarities of the two definitions are worked out and compared.

2nd concept of establishment

2.1. Term of establishment acc. Section 12 AO

The concept of permanent establishment in national tax law is defined in § 12 AO. This definition applies to all tax refunds and taxes that are regulated by federal law acc. § 1 Abs. 1 S. 1 AO Thus, this definition first applies to income taxes. However, the definition is dealt with in a subsidiary manner, which means that if a specific definition has been laid down in individual tax laws or in European law, then this has priority. In § 12 S. 1 AO a very abstract definition for a permanent establishment is first established and in sentence 2 of § 12 AO a non-exhaustive catalogue of examples is given which have permanent establishment quality. According to § 12 S. 1 AO, it is defined that ‘any fixed business establishment or plant serving the activity of an enterprise’ constitutes a permanent establishment under national tax law. A “fixed business establishment” exists if the spatial and temporal components are present. Thus, the prerequisites for a permanent business establishment exist if there is a physical object, a local fixation and the power to dispose of it. This means that the site should be permanently built and also have a connection to the earth's surface. However, a fixed connection to the surface is not necessary. According to the Order on Premises, for example, ships, trucks, aircraft and exhibition stocks do not establish a premises because they do not meet the conditions of local fixation. On the other hand, an underground pipeline, a so-called “pipeline”, of a foreign company in Germany, fulfils the prerequisites for a permanent business establishment and thus also the fact of the establishment is realized. The temporal component is fulfilled if the power of disposal over the use of the taxable person’s permanent establishment is not only temporary but permanent. A power of disposal which fulfils the conditions for a permanent establishment exists only if the taxable person has a legal position which cannot be withdrawn from him without his own cooperation. An example of this would be that BFH does not regard the mere activity on the client’s premises as a permanent establishment, since there is a lack of sufficient power of disposal. In addition, there is no business premises at a stand that is set up annually for four weeks on the Christmas market. There is a lack of durability here. Operating premises according to § 12 S. 2 AO are head offices, branches, offices, manufacturing or workshops, warehouses, buying and selling points and mines, quarries and other sites for the extraction of mineral resources. In addition, installations and constructions that last longer than six months also apply to the operating sites of § 12 S. 2 AO.

2.1.1. Delimitation to permanent representative acc. Section 13 AO

The permanent representative according to § 13 S. 1 AO describes a legal or natural person who sustainably concludes the business of a company, but this does not act independently but is subject to the instructions of the company. The permanent representative has an independent significance in national tax law and is independent of the definition of the permanent establishment of § 12 AO. The "permanent representative" according to § 2a EStG does not establish a permanent establishment under national law. Even under the Trade Tax Act, the independent representative does not constitute a permanent establishment.

In corporate tax and income tax law it is defined that a permanent establishment acc. Section 12 AO is subject to income taxes. It should be noted whether it is a domestic or foreign establishment. If there is a domestic establishment, the entire profit of the company is taxed domestically. In the case of corporations, an unlimited tax liability acc. § 1 Abs. 1 No. 1 KStG. The profit of the corporation is taxed by the corporation tax. In the case of associations of persons, the profit is taxed by the income tax of the individual shareholders, since associations of persons are not independent tax entities under income tax and corporate tax law. As soon as a foreign permanent establishment of a corporation is present, a limited tax liability acc. § 2 KStG in Germany. To qualify the income, § 8 Abs. 1 KStG in conjunction with § 49 EStG. This is then income from business operations acc. § 49 Abs. 1 No. 2a EStG. For the co-entrepreneurs of a domestic partnership with a foreign permanent establishment, this is foreign income from business operations acc. § 34 No. 2a EStG.

2.1.2.2. According to the Business Tax Act

The Trade Tax Act does not have its own definition for the permanent establishment, thus the definition according to § 12 AO results. If a permanent establishment is maintained in Germany, the results of the commercial enterprise are subject to trade tax acc. § 2 para 1 and para 9 no. 3 GewStG. For several establishments in different municipalities ag. § 30 GewStG is to divide the measurement amount to the individual municipalities acc. § 28 Abs. 1 % by weight

2.1.3. Wage tax permanent establishment

The term of permanent establishment tax deviates from the definition of § 12 AO. § 41 para 2 EStG defines the concept of permanent establishment for wage tax. The definition is decisive for the management of a payroll account acc. § 4 LStDV and for the territorial jurisdiction of the tax office for the payment of wage tax. In the payroll tax directive, the term permanent establishment is defined as follows: ‘The permanent establishment subject to payroll tax is the employer’s domestic establishment or part of the establishment at which the wage is calculated as a whole, i.e. where the individual wage components or, in the case of machine payroll, the input values are combined into the wage determining the wage deduction.’ Thus, the permanent establishment subject to payroll tax is not dependent on a “fixed business facility or plant” acc. § 12 AO, but from the determination of the entire wage.

2.1.4. VAT permanent establishment

Domestic sales are subject to VAT. In particular, the place of delivery or other service is decisive here. A permanent establishment is then considered a place of other service, if this was also carried out by the permanent establishment acc. § 3a Abs. 1 S.2 UStG. If other services according to § 3a Abs. 4 UStG is executed to a permanent establishment, the location of the permanent establishment of the recipient of the service is decisive acc. § 3a Abs. 3, p. 2 UStG. For VAT purposes, a permanent establishment is designated if the following circumstances acc. § 12 S.1 AO is given: “any fixed business establishment or plant serving the activity of the company”. Contrary to the requirements of § 12 AO, under VAT law only such establishments are permanent establishments that have the necessary sufficient minimum stock of material and personnel resources for the provision of the other service. In addition, the establishment must have a real equipment that enables independent provision of services and has a sufficient period of time. According to terminology 3a.1 para 3 pp. 1-5 UStAE is a permanent establishment if the business establishment or facility employs a corresponding number of staff, records and accounting are made and business decisions are made.

2.1.5. Establishment under the Conversion Tax Act

In the case of cross-border transfers of assets by a corporation, there is a tax advantage in the case of EU property conduct, if it is a permanent establishment with permanent establishment quality acc. § 23 Abs. 1-3 UmwStG. The concept of establishment according to § 23 UmwStG deviates from the general definition of § 12 AO. The concept of establishment is to be applied in accordance with provisions of international law. This also applies to the definition of the permanent establishment in cross-border special cases of conversion acc. § 3 para 3, § 20 para 7 and § 8 UmwStG.

2.1.6. Definition of permanent establishment for tax deductions

The distributions of a domestic corporation to a foreign corporation of the EU are acc. § 43b EStG is exempted from withholding tax deduction. § 50a EStG regulates the exemption from withholding tax deduction for certain group-internal licence and interest payments in the EU. For this purpose, § 43b para 2a EStG and § 50g para. 3 No. 5c EStG own provisions of the concept of permanent establishment, in which the respective requirements of the EU directives have been taken into account, so that in the case of interpretation decisions are made according to the objectives of the EU directives.

2.2 Term of establishment acc. Article 5 OECD-MA

To avoid double taxation of income and assets, the OECD Model Agreement was drawn up. The national definition is subsidiary for interpretations under agreement law. Section II of the OECD Model Agreement provides for the definition of a permanent establishment, which is relevant for all agreements. For the taxation of corporate profits, the definition of permanent establishments is the decisive factor acc. Article 7 OECD-MA. The permanent establishment principle is intended to ensure that a foreign state can only tax the profits of the permanent establishment once an intensive business relationship with that state has been established.

2.2.1. General definition of the establishment by art. 5 par. 1 OECD Model Agreement

An establishment acc. Article 5 of the OECD-MA provides for the existence of a permanent establishment with control, which is permanently invested and from there the business activity is carried out. This term is defined only on mainland-related premises, since a permanent establishment must exist. Thus, a direct connection to the earth's surface is decisive. A ship carrying goods and passengers would not be a permanent establishment in accordance with the provisions of the Convention because of the conditions of the fixed place of business. In a judgment (I 6/96) of 22 January 2001, the Finanzgericht Hamburg stipulated that a fixed business establishment is to be understood as a material group of entrepreneurial physical objects. However, the Finance Court Hamburg also insists on a local fixation and also on a minimum duration of the existence of the permanent establishment of more than 12 months.

2.2.2. Premises examples according to art. 5 par. 2 OECD-MA

Art. 5 par. 2 OECD-MA contains a non-exhaustive list of standard examples for an establishment. The definition of a permanent establishment is decisive in treaty law for the allocation of the taxation right of a contracting state. The term permanent establishment means, under agreement law, a fixed business establishment in which the business activity of an enterprise is carried out in whole or in part. Premises by type. 5 par. 2 OECD-MA are in particular, the place of management, branches, offices, manufacturing and workshops and mines, oil or gas deposits, quarries of another site for the exploitation of mineral resources. However, the examples listed must always meet the requirements of the species. 5 par. 1 OECD-MA.

Branches are legally dependent subdivisions of an enterprise. They fulfill a certain economic and business independence, which is reflected in the independent conclusion of transactions. A branch therefore carries out not only preparatory auxiliary activities. Registration offices are administrative bodies in which the business activity is carried out. Comparable with the office according to § 12 Abs. 2 No 3 AO. In addition to offices, offices are also other business facilities in which a commercial exercise of the company is also carried out. However, the company must necessarily have permanent control over the other business establishment, otherwise a permanent establishment would not be recognised.

2.2.3. Article 5, par. 3 OECD-MA

Paragraph 3 specifies the concept of establishment in constructions and installations. Constructions and installations shall only be considered as permanent establishments if they exceed their duration of twelve months. A construction is the construction of buildings or installations. Assembly is the assembly or installation of prefabricated parts into a whole. Mere repairs and repairs do not constitute construction or installation. The sole installation of machines, as well as the firm anchoring in the ground, does not constitute an establishment in accordance with the provisions of the Convention.

2.2.4. Article 5, par. 4 OECD-MA

In Art. 5 para. 4 OECD-MA contains a negative catalogue in which facilities and installations are listed which do not constitute a permanent establishment, even if they comply with the criteria of Art. 5 para. 1 and 2 OECD-MA. These are, for example, establishments intended solely for the storage of goods, fixed business establishments which are solely responsible for purchasing goods and obtaining information, or fixed business establishments which exclusively carry out non-company work, preparatory and auxiliary activities. The transport of oil through so-called pipelines does not constitute an auxiliary activity in the sense of the art. 5 par. 4 OECD-MA. This is not the mere delivery of goods of the company, since only foreign oil is transported. The pipeline thus also constitutes a permanent establishment in the sense of agreement law. However, if a main activity and ancillary activity are carried out in a business office and these are economically linked, then there is a single establishment overall. The negative catalogue of Art. 5 para. 4 OECD-MA makes it possible in tax design to restrict or even avoid permanent establishments in accordance with agreements.

2.2.5. representative premises gem. Article 5(5) and (6) OECD-MA

Paragraph 5 describes the dependent representative who has and exercises a power of attorney for the conclusion of contracts. The dependent representative thus establishes a permanent establishment of the company, the so-called representative permanent establishment acc. Article 5(5) OECD-MA. Here the activity of a person i.S.d. Art. 5 par. 5 OECD-MA for the same legal consequences as for a permanent establishment acc. § 5 Abs. 1 and 2 OECD-MA. The activity of an independent representative, such as broker or commissioner, does not normally lead to a permanent establishment of the client acc. Article 5(6) OECD-MA. However, the prerequisite for this is that the order is carried out within the framework of ordinary business activities.

2.2.6. Anti-organ clause Art. 5 para. 7 OECD-MA

Of the kind. 5 par. 7 OECD-MA sets out a regime for affiliated undertakings which takes the form that control alone is not sufficient to make the subsidiary a permanent establishment of the parent company. A controlled company, such as a subsidiary, does not constitute a permanent establishment for the controlling parent company. A permanent establishment under the parent-subsidiary directives is a permanent establishment in a Member State from which the activity of a company of another Member State is carried out, provided that the profits generated are taxable in one of the Member States.

2.2.7. Taxation of profits of a permanent establishment according to OECD-MA

Under international law, the profits of a company of a Contracting State may be taxed in the other Contracting State only if the company carries out its activity through a permanent establishment located in the other Contracting State. The profits attributable to the permanent establishment may be taxed in the other Contracting State. Thus, in the case of a domestic permanent establishment with a foreign capital or partnership, Germany would have the right to tax the profit shares of the domestic permanent establishment. If a domestic company has a foreign permanent establishment, the permanent establishment state also has a right of withholding taxation on the attributable profits of the foreign corporation, provided that there is a DTA. In order to avoid double taxation, the profits are exempted from taxation in a contracting state or the foreign tax paid is charged.

In some points, the definitions of the establishment are similar under national law and under agreement law. The basic requirements for the existence of a permanent establishment in national law and in agreement law are almost identical. Both definitions refer to a fixed business facility and durability. The fixed place of business is defined in both definitions in such a way that a reference to the earth's surface and a power of disposal over it must be provided. However, both definitions show considerable differences in the other points. The first difference in the definitions is reflected in the fact that, according to the tax code, installations are also defined as permanent establishments. According to the OECD Model Agreement, the annexes are ignored. The second difference lies in the definition of entrepreneurial activity. Section 12, p. 1, of the Tax Code states “[...] serves the activity of the company” and in Art. 5 par. 1 OECD-MA ‘[...] the business activity of an enterprise is wholly or partially carried out’. Basically, both definitions are about the fact that the entrepreneurial activity must be carried out at the establishment. In Article 5, par. 2 OECD-MA you will find all examples of companies that are also in § 12 S. 2 AO. § 12 S. 2 AO also listed warehouses, buying and selling points as examples of production sites. According to OECD-MA, these examples are not premises if only preparatory or auxiliary activities are carried out there acc. Article 5(4) OECD-MA. Another difference lies in the constructions and installations. According to national law, a permanent establishment is already located after exceeding six months for construction work and installations in accordance with § 12 S. 2 No. 8 AO. According to the agreement law, a construction or assembly is only classified as a permanent establishment after exceeding twelve months acc. Article 5(3) OECD-MA. In Article 5, par. 5 OECD-MA defines the agent establishment that exists when a dependent agent with power of attorney for contracting acts on behalf of the company. The representative establishment is not explicitly regulated in national law. § 13 AO only describes the permanent representative who does not establish a permanent establishment. This is similar to the independent representative according to art. 5 par. 6 OECD-MA, which also does not normally establish a permanent establishment. The regulations for affiliated companies are only included in the agreement law ag. Art. 5 para 7 OECD-MA. In the national law according to § 12 AO this fact is ignored. It should be noted that the basic requirements of a permanent establishment are similar in national law and in agreement law, but if you go into detail, you can see clear differences that are ultimately decisive for taxation law.

4th Summary

The concept of permanent establishment is regulated under national law in § 12 AO. For purely domestic situations, this definition is relevant, unless a different definition is made in the individual tax laws. Thus, the definition of permanent establishment under the AO is subsidiary compared to the definitions under the individual tax laws. Income tax, business tax and corporate tax refer to the definition from the AO. The definitions of the permanent establishment for payroll tax, sales tax and withholding tax deviate from the general definition of § 12 AO. The permanent establishment in conversion processes also deviates from the definition in § 12 AO. In purely domestic situations, there are different definitions of a permanent establishment for different tax types. Thus, for example, an entity may own a permanent establishment which is treated as such for income tax purposes but is not a permanent establishment from the point of view of payroll tax, since the conditions of a permanent establishment for income tax purposes are more strictly defined.

For foreign affairs in contracting states with which Germany has concluded a double taxation agreement, Article 5 of the OECD Model Agreement defines the permanent establishment. The definition of a permanent establishment in the sense of agreement law is defined in much more detail than that in national law. First there is a general definition in Article 5 of the OECD Model Agreement, then there are some examples of production sites. The agreement law deals more precisely with the problems of construction and assembly in para. 3 of Art. 5 OECD-MA. Moreover, such establishments which carry out only preparatory or purely auxiliary activities are not considered to be permanent establishments. There is no such delimitation in national law. More attention is also paid to the representative operating site and to affiliated companies.

These different definitions lead to different perspectives on the definition of the establishment, especially when dealing with foreign affairs. For this reason, it was stipulated that in the case of foreign affairs with contracting states which have concluded a double taxation agreement with each other, the definition according to the OECD-MA takes precedence over the national definitions.

In the final conclusion, the majority of the differences and deviations listed clearly show that the understanding of a permanent establishment under agreement law is more strictly defined, since the OECD-MA sets out a substantially detailed definition of the permanent establishment as in national law. Accordingly, the entitlement and requirement of subsidiary national and international assessment of the definition of permanent establishments in clear order of precedence is taken into account in order to avoid any conflicting tax assessment and thus ensures a clear regulation.