Redefining the concept of permanent establishment in view of contemporary business models in the digital economy

Abstract

The digital economy has transformed the manner in which business is conducted. Globalisation has made corporations, and the economy, more integrated. International tax is one of the fundamental pillars of the economy, supporting its growth by facilitating cross border trade and investment. Over 3000 bilateral treaties currently in force contain a permanent establishment definition, which serves to allocate taxing rights to either the source or resident state. The concept of permanent establishment places great emphasis on physical presence, in order for an enterprise to establish a sufficient connection to the state. This raises the question as to whether the concept is still effective as a tax allocation mechanism when the spread of technology across business sectors is steadily eroding the physical presence requirement. This thesis will assess whether the concept of PE is suited to cope with advances in technology, and whether it requires review as a result. An analysis of the intention and purpose behind the concept of permanent establishment reveals that, with respect to the traditional economy, permanent establishment has achieved its intended objectives. However, in the transition to the digital economy, the concept has struggled to adapt and keep up with the pace of development. This arises from an analysis of the tax treatment of server-PEs, which leave gaps and uncertainties of interpretation. An analysis of the characteristics of the digital economy and contemporary business models further exacerbates these concerns, and confirms that the issues faced by PE may continue to grow. The international community has reacted by proposing a number of alternative solutions to the problem. An assessment of three solutions concludes that a less radical version of the ‘significant digital presence’ option proposed by the OECD would be most viable, provided that deminimis requirements are introduced in order to avoid the proliferation of permanent establishments where a negligible amount of tax is to be collected.