Treatment of service permanent establishments

By Larsen Lüngen from ECOVIS Cologne and Krefeld

A permanent establishment is a dependent branch of an enterprise that is usually subject to income tax and value added tax in a respective country. It is in general a fixed place of business, which serves a company’s activities. National Chinese and German tax law define the term permanent establishment and the application of respective taxes.

Following a strict definition of permanent establishment according to the OECD Model Tax Convention, negative tax consequences might occur in countries that provide services in other countries, especially as a number of services have been outsourced to other parts in the world, such as China, within the last years.

The U.N. is, besides the OECD, responsible for Model Tax Convention, especially for non-OECD member states. The U.N. has made suggestions of adding service permanent establishments in a Model Tax Convention. From a German perspective, the double taxation treaty with the People’s Republic of China is one of a few exceptions that added a definition of service permanent establishments in Art. 5 (3b).

The term permanent establishment includes the furnishing of services, including consultancy services, by an enterprise of a Contracting State through its employees or other personnel, when the activities in the other Contracting State (for the same or a connected project) continue for a period or aggregating more than 6 months within any 12-month period.

As a consequence the definition of project is decisive and not the definition of a fixed place of business. A consultancy company has to register in China, if it worked on a technological project in Shanghai for 4 months and in Beijing for 4 months within a period starting March 2012 until April 2013, although it does not have a fixed place of business.

However, the foregoing example leads to a conflict of the right of taxation, based on the national, German definition of a permanent establishment, which defines a right of taxation in Germany as well.

The before mentioned conflict also applies for income taxes, wage taxes and value added taxes, as the respective tax laws refer to the definition of permanent establishment according to national regulations.

In the future tax objectives and permanent establishment policies should be considered before signing a Chinese-German service contract in order to prevent negative consequences. Clear conditions can be created, if a fixed place of business is rented for the period of a project, as the definition of a permanent establishment is met by domestic regulations and bilateral agreements. This way certainty is ensured while doing business in China.