Services Permanent Establishment
according to the Czech Double Taxation Treaties and Czech National Legislation
Jaroslava Fojtíková from Peterka & Partners, v.o.s.
During the communist period and in the early 1990s, the Czech Republic
gave only limited attention to international trade development and Double
Taxation Treaties (“DTT”). After the Velvet revolution in 1989 and with the
change in the economic situation of the Czech Republic, certain provisions of
existing DTTs proved to be deficient and adapting them to the new circumstances
appeared inevitable. As a result, the Czech Republic now intends to renegotiate
the DTTs concluded during this period.
In the DTTs which were concluded after the early 1990s and mainly in
recent years, the Czech Republic sought an arrangement not only as regards the
conditions of the creation of a “fixed” permanent establishment, but also
concerning the implementation of the concept of a “services” permanent
establishment (e.g. DTT with the Slovak Republic or new DTTs with France or
Austria).
The issue of permanent establishments has an important practical impact,
since following the creation of a Czech permanent establishment, the income
received by a foreign entrepreneur through this permanent establishment is
subject to taxation in the Czech Republic and, moreover, the creation of a
permanent establishment results in a related administrative burden (e.g.
registration obligation, obligation to file a Czech tax return, administration
related to employees of the permanent establishment in certain cases).
Permanent Establishment within the Meaning of the OECD Model Tax
Convention
Conditions for the creation of a permanent establishment are usually
regulated by DTTs concluded between the particular states involved and/or in their
national income tax legislation, so they can vary from state to state. These
differences may, and often do, result in practical difficulties and
complications as far as cross-border trade is concerned. However, the majority
of DTTs concluded between developed states is negotiated according to the
wording of the OECD Model Tax Convention on Income and Capital (“Convention”).
The Convention defines the term “permanent establishment” as a fixed
place of business through which the business of an enterprise is wholly or
partly carried on. In
compliance with this definition, the main condition for the creation of a
permanent establishment is the existence of a place of business of the foreign
entity (i.e. a facility such as premises, machinery or equipment) which is
fixed (i.e. must be established at a distinct place with a certain degree of
permanence). The legal relationship of the entity to the place of business is
not important, i.e. it is not decisive whether the facility through which the
business is carried on is in the ownership of the respective entity, rented or
just left at the entity’s disposal without any legal right.
Permanent Establishment in the Double Taxation Treaties Concluded by the
Czech Republic – Concept of a Services Permanent Establishment
The provision on a services permanent establishment negotiated in the
Czech DTTs goes further than the understanding of permanent establishments
within the meaning of the Convention, as it assumes creation of a permanent
establishment based on the mere provision of services in the territory of
another state for a certain period (specified in the DTT), even if the business
is not carried on through any fixed place of business. The tax consequences of
the creation of a services permanent establishment are generally the same as
for a fixed one.
This trend reflects the opinion of the Czech Republic on the issue of
permanent establishments as mentioned in the Reservations on Article 5 of the
Convention. The Czech Republic reserved “the right to propose in bilateral
negotiations specific provisions clarifying the application of this principle
to arrangements for the performance of services over a substantial period of
time”. Usually, in the DTTs concluded by the Czech Republic, this period is
agreed as six months in any 12 consecutive months.
As a result of the above provision negotiated in the Czech DTTs, a
services permanent establishment of a foreign entity on the territory of the
Czech Republic may be created, for example, in the following case:
The work of a consultant performed at different branches in separate
locations pursuant to a single project for training the employees of a bank,
i.e. he or she moves among separate locations. (This situation is expressly
addressed in the Commentary on Art. 5 of the Convention. The Czech Republic
declared in the Observations on the Commentary its view that a permanent
establishment may also be created if services are provided over a substantial
period of time.)
It is true that cases where a foreign entity provides services in
another state for a significant period without having a fixed place of business
there are quite rare and usually it is possible to identify a place which can
be deemed as a fixed place of business. Nevertheless, even if in these cases a
permanent establishment is created anyway, the reasons for its creation
understood by the Czech Tax Authorities could differ from the understanding of
the Convention.
A common situation is that of employees of a parent company who are sent
to its Czech subsidiary to provide consulting or management services to this
subsidiary. These employees usually have at their disposal a certain place,
being an office or even just a desk, where they may perform their activities.
As mentioned above, the legal rights to this place are not important, so it may
be left at their disposal without any special legal act. In compliance with the
Convention, if the above activities of employees show a certain degree of
permanency, a fixed permanent establishment of the foreign company is created.
According to the regulation on services permanent establishment
negotiated in the Czech DTTs, if these services are provided for a period
exceeding six months in any 12 consecutive months (or another period stipulated
in the respective DTT) they result in the creation of a services permanent
establishment and the fact, whether there is a fixed place of business (certain
degree of permanency) is usually disregarded.
Double Taxation Treaties Concluded by the Czech Republic Lacking
Provision on Services Permanent Establishments
More serious problems may arise concerning entities from countries whose
DTT concluded with the Czech Republic does not contain regulation of services
permanent establishments (mainly DTTs concluded up to the early 1990s).
The national Czech tax legislation stipulates the creation of a Czech
services permanent establishment of a foreign entity based on the provision of
services in the Czech Republic for a period exceeding six months in any 12
consecutive months. Under Czech law, the provisions of international treaties
that are binding on the Czech Republic and that have been ratified by the Czech
Parliament shall prevail over national law. Moreover, Czech income taxes
legislation contains analogous provision on the priority of binding
international treaties. Therefore, the above national regulation on the
creation of services permanent establishments is to be applied only if such a
binding international treaty does not stipulate otherwise.
The issue remains whether DTTs not containing provision on services
permanent establishments “stipulate otherwise” in the sense that they prevent
the application of national Czech regulation of a services permanent
establishment. According
to the Czech Ministry of Finance (which is the supreme authority with regard to
tax matters), the concept of a services permanent establishment in Czech
national legislation may be applied in these cases as it is not in conflict
with the respective DTTs (the list of facilities and situations to be regarded
as being/leading to permanent establishments in the DTTs is only
demonstrative). Consequently, this opinion is followed by the tax
administrators in everyday practice, even if it is contrary to certain
judgments of the Czech courts, which have confirmed that in these cases the
regulation on services permanent establishment set out by Czech legislation
cannot be applied.
The issue of Czech
services permanent establishments is complicated and it is necessary to address
it on a case-by-case basis. Moreover, in the case of potential disputes with
the Czech Financial Authorities, sophisticated argumentation plays a very
important role. Therefore, it is highly recommendable to always consult a Czech
professional tax advisor in this respect.
