The international tax community is consumed with re-evaluating the utility and adequacy of typical markers of international tax jurisdiction, associated among others with the tax treaty notion of “permanent establishment”. In this context, a PE, as it is known, is a description of what is considered to be a sufficient intensity of business presence in a country where a taxpayer earns income, to warrant that country’s unrelieved tax claim on that income, usually the income that is functionally and financially attributable to activities and commercial opportunities in that country. This preservation of jurisdiction to tax for taxpayers otherwise considered to carry on business in the country is usually found in Articles 5 and 7 of a tax treaty conforming to model tax treaties of the Organisation for Economic Co-operation and Development (OECD) and the United Nations – which includes Canada’s tax treaties.
Presently, the tax world is focused on the viability of necessary connections to determine a PE, in the first instance because of the opportunities offered to businesses that are “digital” or that conduct business “digitally” effectively to be everywhere and nowhere at the same time – in other words, to be “virtual” in a tax world that historically is very much driven by notions of tangible, observably physical presence. The OECD’s Pillar One and Two and related GloBE proposals confront the present concern that typical markers of tax jurisdiction associated with PEs as commonly understood will exclude considerable income from the tax bases of countries where, it is thought, that income will have been “earned” – itself a contentious notion in so far as the “source” of income is not normative, is not determined according to universally applicable notions, in fact is intrinsically a legal notion in a world where neither legal nor tax systems are harmonized or systematically co-ordinated. A topical example of the perceived infirmity of the PE notion and related connections to income “sources” which typically inform jurisdiction to tax is the practical view taken by the OECD to relax the observance of those tenets of jurisdiction to tax where taxpayers’ observance of them is incapacitated or compromised because of the COVID-19 pandemic. If anything, the flexible approach taken by the OECD, with which Canada’s approach too is consistent, raises questions about why the venerable tests of taxable presence, in themselves, ever really mattered except the sense that they describe, it is argued not absolutely or exclusively, a certain intensity of carrying on commercial activity coupled with a certain connection with and dependency on the income earning environment of a country that justified its assertion of a tax claim. In other words, the tests of taxable presence are descriptive and not prescriptive, though the overwhelming tendency is to seem them as prescriptive, occasioning the concern, then, about being out of sync with how contemporary business is conducted.
In particular, the alleged incapacity of jurisdictional tests arises from the mobility and malleability of “intangibles” particularly in the – manifestations of business inputs and “products”, that is, “goods” and “services, that are not physical but are seen as the most valuable of business inputs and, in the contemporary world, outputs. The significance of “intangible value” for the effective assertion by countries of non-duplicative tax claims is not new; other of my blog posts draw attention to this in the earliest stages of “modern” international taxation after the First World War, under the auspices of the League of Nations.
In a presentation in 1996 that can only be described as prescient, Dr. Mervyn King, who is a former Governor of the Bank of England and then was the Executive Director and Chief Economist of the Bank of England, commented on “dematerialization” in an Jubilee program of the International Fiscal Association Fiftieth Congress (Jubilee Symposium, “Visions of the Tax System of the XXI Century”, Geneva, International Fiscal Association, September 5, 1996. Again, we find that what is captivatingly “new” is not new at all, though no less demanding of our critical faculties to address. King wrote: “As far as economic activity is concerned, there has been an enormous increase in the proportion which represents output that can be replicated without the use of additional inputs. Such activity has been described as "dematerialised" by Quah (1996). As he puts it: "When economic value - produced and consumed - is embedded in bits rather than atoms, .... international trade becomes not a matter of shipping wine and textiles from one country to the next, but of bouncing bits of satellites. With economic value having no clear points of fiscal entry and exit, international trade statistics become that much murkier and ambiguous. Keeping track of trade is no longer just counting the bottles and bales that pile up on the loading docks in a port. ... An example of "dematerialisation" is satellite television. Governments will find it increasingly difficult to charge VAT on the consumption of satellite television programmes as the technology of decoders develops, and services can be received and paid for on the Internet. They could only, and at some expense, block the transmission of programmes altogether, and even that may prove troublesome with the Internet. … More and more commodities will be of this kind. Computer software, representing entertainment, education and information of all kinds, will be transferred from firms to their customers, and from country to country, in ways that the tax authorities may find impossible to monitor. Value added can pass down telecommunications lines. Surgeons can perform operations on patients many hundreds of miles away using remote control access to instruments controlled by robots. One day, when technology becomes sufficiently cheap, the same might be possible for a wide range of personal services from healthcare to haircuts. … The power of dematerialisation is that since additional sales require no further additional inputs, the possibility of cross-checking between a firm's purchases of inputs and its sale of outputs is broken. Tax assessment becomes more difficult.””
A recent short publication by the legal publisher Kluwer (July 15, 2020) in connection with its publication of Arvid Skaar’s seminal book on PE offers nuggets of insight about Skaar’s view of the viability of the PE notion of taxable presence. Skaar, as this publication notes, is without overstatement possibly the leading international commentator on PE. In it, the following is said about Skaar’s views: “Speaking with Arvid clarifies one thing regarding PE: It should be remembered that countries interact with each other regarding taxation on a tacit yet entrenched quid pro quo basis in which taxation norms and principles are respected for the most part. Reciprocity and mutual respect is the name of the game. No country likes to step too far out of the ‘circle of understanding’ regarding taxation issues, particularly if they are members of the Organisation for Economic Co-operation and Development (OECD). Even so, some countries, in opposition to others, no doubt felt constrained by the rigours of the PE principle, which, as Arvid argues, is a principle in decline in particular for new industries. Its erosion has meant the ability of countries to increase the taxation of foreign entities’ income at the income source. … We always like to conclude our interviews with experts with a simple question, which we also asked of Arvid: What does he believe will be the major disruptor or disruptors in his field in, say, the next 5-10 years? Arvid contends that the issues of ‘non-physical presence’ will continue to be a hot-button issue for tax authorities regarding tax rules internationally for some time to come. Arvid further contends that PE will become increasingly obsolete as more business goes online and as more companies no longer require a physical presence in countries, in which they conduct business. … Arvid is convinced about one thing: “The erosion of PE will continue”. As stated before, he believes this is a positive trend. The limits of PE, in his opinion, mean that it impedes international trade. The PE principle does not contribute to neutrality in taxation. In some cases, competitors are not taxed in the same way as their competitors in the very same market. Arvid notes how there is a trending belief that companies should not be taxed according to PE and residency principles but rather on a ‘fairer’ system based on the company’s actual revenue-related presence in the market. He believes this equitable approach will benefit the community. “International trade will benefit from modifications in the PE principle,” he concludes.”
Skaar’s comments as recounted in the Kluwer note remind us in a pointed fashion about the intrinsic connection between tax and trade, and that connection the importance of understanding the fiscal underpinnings of a country’s tax system which are enabled by purposive taxation. This focus, indeed, does draw attention to the utility and adequacy of markers of tax jurisdiction, but perhaps not to suggest that they be abandoned but instead to insist that we try harder to understand them in a critical way – a way that reflects enduring undercurrents of taxation and inter-nation accommodations of each other’s fiscal condition and associated tax claims.