Permanent Establishment and the Challenges of Electronic Commerce

• Author: David E. Spiro & Kate Lazier
• Pages: 99-114

99

Chapter 6

Permanent Establishment and the

Challenges of Electronic Commerce

david e. spiro & kate lazier

A. INTRODUCTION

Electronic commerce, or e-commerce, has revolutionized business. The in-

ternet facilitates global commerce by bringing together buyers and sellers

from all over the world. The traditional need for a physical place from which

to conduct business is disappearing. Sales teams are no longer a necessity.

This paradigm shift in business is challenging tax laws. Governments have

struggled over the past decade to determine how to fairly and eff‌iciently tax

e-commerce in the context of tax systems that are based on physical assets

such as off‌ices, warehouses, and employees. This tension is ref‌lected on

the international level as countries begin to apply the concept of permanent

establishment to e-commerce.

This chapter starts with a brief summary of the concept of permanent

establishment. E-commerce itself is explained in order to better understand

how it operates. These concepts are then synthesized to clarify t he issues

that e-commerce presents within the current international ta x system,

which is based on permanent establishment. The second part of the chap-

ter reviews t he approach that t he Organisation for Economic Co -operation

and Development (OECD) has taken on this issue. The chapter concludes

with a brief look at developments in Canada, Australia, Germany, United

Kingdom, Spain, and Portugal.

100 david e. spiro & kate la zier

B. PERMANENT ESTABLISHMENT

Typically, countries impose tax on their residents as well as non-residents who

have a permanent establishment in t he country. The presence of a perma-

nent establishment determines whether a person will be taxed in a country

in which he is not resident. T he roots of the concept of permanent es tablish-

ment can be traced back to Germany and Prussia in the mid-nineteenth

century with a more modern version appearing in the League of Nations

1923 report.1 The per manent establishment test was constructed to avoid

double taxation as jur isdictions agreed on a common standard to deter mine

which jurisd iction had the right to tax t he business prof‌its of an entity.2 The

concept aims to tax entities with signif‌icant presence or participation in the

economic life of a jurisdiction .3 Arguably, this system attempts to tax those

who benef‌it from t he infrastr ucture provided by the jurisdiction. A signif‌i-

cant economic presence in a country also offers a convenient collection and

enforcement point for the taxes. The administrative burden on corporations

is also reduced – there is no obligation to f‌ile and pay taxes in every jur isdic-

tion in which the corporations have minimal economic activity.4

Canadian tax t reaties generally incorporate the meaning of permanent

establishment in Article 5 of the OECD Model Tax Convention on Income

and Capital (OECD Model Convention).5 The OECD Model Convention is

acco mpan ied by Comm enta ry i ntend ed to ref‌le ct th e cons ensu s of t he me m-

ber nations on t he interpretation and application of the OECD Model Con-

vention. It should be noted that the relevance of the OECD Commentary on

the OE CD Model Con vention in interpre ting Ca nadian t ax treat ies is not ye t

well established by Canadian tax cases, particula rly in the case of a treaty

entered into before the relevant Commentary was adopted. In the OECD

Model Convention, the term “permanent establishment” means a “f‌ixed

1 L. Hinnekens , “Looking for an Appropriate Jur isdictional Framework for Source State Tax a-L. Hinnekens , “Looking for an Appropriate Jur isdictional Framework for Source State Tax a-

tion of Internationa l Electronic Commerce in the Twenty-f‌i rst Century” (1998) 26 Inter tax

192 at 196.

2 S. Matthews, “Water Runs Downhi ll: Interprovincial Tax Pla nning” Report of t he Fifty-Sixth

Tax Conference (Toronto: Canadia n Tax Foundation, 2004) 25:1-50 at 25:23.

3 Commentary to Ar ticle 7 of Organisation for Economic Co -operation and Development,

Model Tax Convention on In come and on Capital (Pari s: OECD, 2003) at paragraph 3 and J.

Hayre, “Residents Car rying on Business in Ca nada” in 2002 British Co lumbia Tax Confer-

ence (Vancouver: Canadian Tax Fou ndation, 2002) 12:1-27.

4 W. Szyc, “Revenue Canada’s Perspect ive on Electronic Commerce” in Rep ort of the Forty-

Ninth Tax Conference ( Toronto: Canadian Tax Foundat ion, 1998) 53:1-14.

5 Orga nisation for Economic Co-operat ion and Development, Model Tax Conventio n on In-

come and on Capita l (Paris: OECD, 2003) [OECD Model Convention].