In the current era of globalisation and cross-border trade, the concept of Permanent Establishment (‘PE’) assumes paramount importance from an international tax perspective. It is relevant in the light of the fact that the Organisation of Economic Council and Development (‘OECD’) has taken up initiatives to Base Erosion and Profit Shifting,with the intention of shifting profits to low-tax or no-tax jurisdictions. KSA and UAE are also signatory to the OECD Model Convention with respect to Taxes on Income and on Capital (‘OECD Model Treaty’), underscoring their commitment to prevent Base Erosion and Profit Shifting.
Additionally, effective from 1 January 2020, KSA and UAE have entered into Double Tax Treaty (‘UAE-KSA DTT’), which covers residents of the UAE and KSA, including any free zone companies situated in the UAE. The provisions mentioned in the DTAA override the KSA Domestic Laws governing corporate income tax.
In connection with the above, business enterprises based in the United Arab Emirates (‘UAE’),which are involved in cross-border trade with their customers located in the Kingdom of Saudi Arabia (‘KSA’) maybe subject to PE implications in the KSA.
In this Article, we have covered the fundamental concept of PE, along with specific provisions applicable in KSA and the recently introduced UAE-KSA DTT.
General concept of PE
Fundamentally, the rationale behind the PE concept is to allow, within certain limits, the taxation of non-resident enterprises in respect of their activities (having regard to assets used and risks assumed) in the source jurisdiction. As per Article 5 of the OECD Model Treaty, an overseas resident has a substantive presence in a ‘state’ (i.e. a country), if he meets the threshold of having a PE. Further, once a PE is established, the next step is to look at how profits are attributable to that PE.
In its simplest form, a PE exists where a company is resident in one country (referred to as the head office) but also has a business conducted from a fixed base in another country (the branch). In its more complex form of a deemed PE, it is a tax ‘fiction’ enabling tax authorities to impose corporate taxes on the deemed branch. A third type of PE is again a tax fiction where there is a deemed branch providing services.
PE and KSA Tax Laws
In principle, all PEs in the KSA are required to comply with the Saudi tax laws. This includes Corporate Income Tax, Withholding Tax (‘WHT’) and Transfer Pricing filing requirements. The implications of PE on Value Added Tax are discussed separately.
Pursuant to Article 4 of KSA Income Tax Law, PE consists of the permanent place of the non-resident’s activity through which it carries out business, in full or in part, including business carried out through its agent.
Further, Article 4ibidprovides that construction sites, assembly facilities, installations, natural survey sites as well as connected supervisory activities are regarded as PE. A fixed base for a non-resident natural person, or a branch of non-resident company is also regarded as PE in KSA.
Some typical PE examples in the KSA
Construction site PE
As per Article 5(3) of OECD Model Treaty, a building site or installation project constitutes a PE only if lasts more than 12 months. It is pertinent to note that no minimum period applies as per Article 4 of the KSA Income Tax Law mentioned above. However, as per UAE and KSA DTT, a building site, a construction, assembly or installation project, or supervisory activities in connection therewith will constitute a PE only if such activities continue for a period of more than six months.
As per Article 5(3)(b) of the UAE-KSA DTT, the furnishing of services, including consultancy services, through one or more employees or other personnel engaged by the enterprise for such purpose forms a PE if activities of that nature (for the enterprise itself or an associated project) continue within the Contracting State for a period or periods aggregating more than 183 days within any 12-month period.
The Agency PE comprises cases where a PE is created if a person habitually concludes contracts on behalf of enterprises. In relation to this, the OECD Model Treaty provides that where the intermediary ‘habitually’ plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification” by overseas company. Article 5(6)(b) of the UAE-KSA DTT also acknowledges this meaning that an agent who has no authority to conclude contracts, but habitually maintains a stock of goods or merchandise from which such agent regularly delivers goods or merchandise on behalf of the enterprise, will be a PE if the agent is not of an independent status.
Non-residents and withholding tax refund claims (‘Virtual PE’)
In addition to the above concepts of PE, the General Authority of Zakat and Tax (‘GAZT’) issued an internal guidance note to itsbranches and divisions on withholding tax refund claims in treaty situations, in which it considers that anon-resident party providing services in KSA will be regarded as having a PE therein, if the periodof the contract under which the services are rendered exceeds the time threshold defined in the relevanttreaty (i.e. generally 183 days) regardless of the fact that the services were not physically rendered inSaudi Arabia.
As per Article 5(4) of OECD Model Treaty, the establishments that perform activities which are in the nature of preparatory or auxiliary to the business are not sufficient to create a PE. However, Article 5(5) of the KSA-UAE DTT provides that the exemption for auxiliary and preparatory activities will not apply to a fixed place of business used or maintained by an enterprise if the enterprise, or a connected enterprise, carries on business activities at that same place, or at another place in the same state, and (a) that place or other place constitutes a PE for the enterprise or the closely related enterprise; or (b) if the business activities constitute complementary functions that are part of a cohesive business operation and are not of a preparatory or auxiliary character.
PE and Value Added Tax (‘VAT’)
The concept of PE is recognised as a ‘place of business’ or ‘fixed establishment’ in KSA VAT Law. As per Article 1 of the GCC VAT Agreement, a ‘fixed establishment’ is a fixed location with the permanent presence of human and technical resources in such a way as to enable the Person to supply or receive Goods or Services.
Furthermore, even if there is no ‘place of business’ or ‘fixed place of establishment’, a non-resident making taxable supplies in the region may be required to obtain a non-resident VAT registration and have a‘Tax representative’ in the KSA for discharging the VAT related obligations.
Business enterprises resident in the UAEand providing of goods or services to KSA customers should examine whether the business activities carried on by them constitute PE as per the above provisions, and whether relief provisions as mentioned in UAE-KSA DTT can be applied to seek relief. A substance over form approach should be adopted to analyse the substance of the transactions over and above the underlying documentation of contracts, invoicing parties etc. Again, for VAT, the transactions need to be analysed in order to avoid any penalties for failure to obtain registration, or payment of VAT to GAZT.