On 22 December last year the OECD released the results of a study on the application of the "permanent establishment" definition in e-commerce. This is an important issue in the context of double tax agreements, because such agreements typically prevent a country from taxing business profits derived by a non-resident unless they can be attributed to a permanent establishment of the non-resident in that country. Thus a New Zealand enterprise carrying out e-commerce business operations over the worldwide web will be subject to tax in other countries only if the enterprise is found to have a permanent establishment in those countries. Conversely, non-residents conducting e-commerce in New Zealand will be subject to New Zealand tax only if found to have a permanent establishment in New Zealand.
The OECD has concluded that:
- a web site cannot, in itself, constitute a permanent establishment;
- a web site hosting arrangement - where the web site of a business is hosted by an Internet Service Provider (ISP) - typically does not result in a permanent establishment;
- an ISP will not typically constitute a dependent agent of another enterprise so as to constitute a permanent establishment of that enterprise; and
- a business that owns or leases a server will not necessarily have a permanent establishment where the server is located.
The major finding is that a web site cannot, in itself, constitute a permanent establishment.
It is common for the web site through which an enterprise carries on its business to be hosted on the server of an ISP. However, although the fees paid to the ISP under such arrangements may be based on the amount of disk space used to store the software and data required by the web site, these contracts do not result in the server and its location being at the disposal of the enterprise. The enterprise therefore cannot be considered to have acquired a permanent establishment by virtue of that hosting arrangement.
It is less common for an enterprise carrying on business through a web site to have its own server (either leased or owned). If this situation arises, however, the place where the server is located could constitute a permanent establishment of the enterprise if all the other requirements for a permanent establishment are met. For example, the activities carried out through that server would have to be "core-business" activities such as retail sales or concluding contracts. Activities that are preparatory or auxiliary in character, such as advertising, gathering market data for the enterprise, or supplying information, are specifically excluded from the permanent establishment definition.
Also, the server must be fixed in location for a sufficient period of time so as to become fixed within the meaning of the "permanent establishment" definition (which implies that regularly moving a server may be sufficient to prevent the application of the permanent establishment provisions).
Inland Revenue, a member of the OECD's Committee on Fiscal Affairs, supports these findings. Another issue, however, one not yet addressed by the OECD, is that of determining what profits can be attributed to the permanent establishment should one be considered to exist. The OECD has noted that it "is unlikely that much tax revenues depend on the issue of whether or not computer equipment at a given location constitutes a permanent establishment", and is continuing work in this area.
Finally it should be noted that the OECD's findings constitute a consensus view, and individual member countries may choose to develop their own rules on the issue.
The results of the OECD study are available on the OECD website at http://www.oecd.org/daf/fa/material/mat_07.htm.
Graham Hunt, Senior Policy Analyst
Peter Frawley, Senior Policy Advisor