Introduction 

Double Taxation Avoidance Agreements (DTAAs) lay down the rules for taxation of income by the source country and the residence country. Such rules are laid for various categories of income e.g. interest, dividend, royalties, capital gains, business income etc. Each such category is dealt with by separate Article in the DTAA. The popular models for Double Taxation Avoidance Agreements (DTAAs) are OECD, UN, US Models. The DTAAs signed by the countries are generally based on such models. A DTAA signed on the basis of a particular model generally follows the provisions prescribed in the respective articles of such models. The articles of such models DTAAs lay down the rules for taxation of income by the source country and the residence country. Such rules are laid for various categories of income e.g. interest, dividend, royalties, capital gains, business income etc. Each such category is dealt with by separate Article in the DTAA.

Article 7 of the DTAA deals with business income. In terms of this Article business income is subject to tax in the source country only if such business is carried on in the source country through a Permanent Establishment situated in such country.

Article 5 of the DTAA defines the term Permanent Establishment. A Permanent Establishment in the source country is considered as a substantial participation in the economic life of such country and accordingly it is taken as a criterion for taxing business income of a non-resident in the source country.

Taxation of an ‘Enterprise’

Article 7 of the DTAA deals with taxation of business profits of an ‘enterprise’. Accordingly, it becomes imperative to analyse the term ‘enterprise’.

“Enterprise of a contracting state”

Article 3(1)(c) of the DTAA defines this as follows:
“the terms ‘enterprise of Contracting State’ and ‘enterprise of other Contracting State’ mean respectively an enterprise carried on by a resident of a Contracting State and an enterprise carried on by a resident of other Contracting State”

“Enterprise”

The DTAA however does not define the word “enterprise”. Meaning given to the term “enterprise” in some of the dictionaries may be considered: The Oxford English Dictionary gives the following meaning of the word “enterprise”:

• a bold undertaking
  
• an initiative and resourcefulness
  
• a business activity
  
• a large project

The Blacks Law Dictionary defines the term enterprise as:

• a business venture
  
• undertaking

Chamber’s 20th Century Dictionary gives the following meanings for the term enterprise:

• an undertaking
  
• a bold or dangerous undertaking
  
• readiness
  
• initiative
  
• daring in undertaking
  
• a business concern

The Webster’s Dictionary gives the following meanings for the word enterprise:

• design
  
• undertaking, usually a bold or difficult one

Article 3(1)(c) uses the words “enterprise carried on by a resident”.

Article 7(1) uses the words “unless the enterprise carries on business through a permanent establishment ….”.

From the above dictionary meanings, in the context of Article 7, “a business activity”, “an undertaking” “a business concern” or “a business venture” seems to be the appropriate meanings.

Hence, the word ‘enterprise’ may be interpreted to mean ‘a business unit’ or a ‘business entity’. This also indicates that an enterprise is not same as resident but an enterprise is a part of resident or part of activities of resident.

Taxation of a resident v. taxation of an enterprise

It is interesting to note that although the benefit of DTAA is available to a ‘person’ (In terms of Article 3(1)(a) of the DTAA the term ‘person’ includes an individual, a company and any other body of persons) who is ‘resident’ (Article 4 of the DTAA defines the word ‘resident’) of a Contracting State, analysis of various articles of the DTAA indicates that some of them deal with taxation of ‘resident’ whereas some of them lay down rules for taxation of an ‘enterprise’.

The following Articles deal with taxation of a ‘resident’:

Article 6 deals with ‘income derived by a resident’ from immovable property
Article 10 deals with ‘dividend paid to a resident’
Article 11 deals with ‘interest paid to a resident’
Article 12 deals with ‘royalties paid to a resident’
Article 13 deals with ‘gains derived by a resident’
Article 14 deals with ‘income derived by a resident in respect of professional
services’
Article 15 deals with ‘remuneration derived by a resident from an employment’
Article 16 deals with ‘director’s fees derived by a resident’
Article 17 deals with ‘income derived by a resident’ as an artist or an athlete
Article 18 deals with ‘pensions paid to a resident’
Article 19 deals with ‘income of a resident in Government service’
Article 20 deals with ‘income derived by a resident as a student’
Article 21 deals with ‘other income of a resident’

The following Articles deal with taxation of ‘an enterprise’

Article 7 deals with ‘profits of an enterprise of a contracting state’
Article 8 deals with ‘profits from operation of ships or aircraft of an enterprise’
Article 9 deals with ‘associated enterprises’

The above analysis indicates that the DTAA uses the words ‘resident’ or ‘enterprise’ discreetly.

Article 7, Article 8 and Article 9 uses the word ‘enterprise’ as against ‘resident’. The benefit of these Articles is available to ‘an enterprise’. However, it would not be possible to argue that ‘a resident’ would not be entitled to the benefit of these articles as the enterprise belongs to the resident and hence it is the ‘resident’ who
is ultimately covered by these articles.

The issue that arises is, if the ultimate benefit is going to the resident then why the word ‘enterprise’ is used in the above articles. In other words the wordings of Article 7 could have been ‘Permanent Establishment of a resident of a Contracting State’. Article 8 could have used the words ‘profits from operations of ship of a resident’. Similarly, even Article 9 could have been worded.

The above phraseology probably indicates the scheme of the DTAA. DTAA seeks to give distinct treatment to a business unit (an enterprise), which earns active income, whereas passive income of resident (e.g. dividend, interest etc.) is treated separately. In case of an active income a non-resident’s participation in the economic life of a Contracting State is substantial. Such income is accordingly more exposed to the domestic laws of the source country.

The following provisions further support the view that DTAA seeks to give distinct treatment to income of a business unit (an enterprise):

• In terms of the provisions of Article 10(4) of the DTAA, if the shares in respect of which the dividend is declared is connected with the Permanent Establishment or a fixed base in the other State, the provisions of Article 10 would not apply. Such income would be covered under the provisions of Article 7 or 14 (Article 14 is deleted in 2003 Model of OECD) as the case may be.
  
• In terms of the provisions of Article 11(4) of the DTAA, if the debt claim in respect of which the interest is earned is connected with the Permanent Establishment or a fixed base in the other state, the provisions of Article 11 would not apply. Such income would be covered under the provisions of Article 7 or 14 as the case may be.
  
• In terms of the provisions of Article 12(3) of the DTAA, if the right or property in respect of which the royalty income arises is connected with the Permanent Establishment or a fixed base in the other state, the provisions of Article 12 would not apply. Such income would be covered under the provisions of Article 7 or 14 as the case may be.
  
• Article 24(4) specifically deals with non-discrimination as regards taxation of a Permanent Establishment.

Permanent Establishment of an enterprise v. Permanent Establishment of a resident

It is interesting to note that the wordings of Article 5 indicate that the Permanent Establishment is of an enterprise rather than of a resident.

Article 5(1) “For the purpose of this convention the term ‘Permanent Establishment’ means a fixed place of business through which the business of an enterprise is wholly or partly carried on”.

Article 5(6) “An enterprise shall not be deemed to have a permanent establishment in a contracting state merely ….”
The above wordings suggest that a Permanent Establishment is of an enterprise. However, since the enterprise belongs to the resident the Permanent Establishment also automatically belongs to the resident. Hence, a Permanent
Establishment of an enterprise is essentially a Permanent Establishment of a resident.

Business profits of an enterprise v. business profits of a resident

In terms of the provisions of Article 7(1) “ Profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a Permanent Establishment situated therein.”

The profits of an enterprise are essentially that of a resident. However, the converse is not true i.e. the profits of resident need not be that of an enterprise.

Example

Let us consider a multinational company A Ltd. with diversified business activities. Such company is engaged in business of garments as well as business of cement. A Ltd. is resident of Country X and has a branch in Country Y which is engaged in the business of garments.

If the term ‘enterprise’ is interpreted to mean ‘a business activity’ or ‘a business unit’ then A Ltd. has two enterprises i.e. ‘garment enterprise’ and ‘cement enterprise’. The profits of both the enterprises are profits of A Ltd. but the profits of cement enterprise are not profits of garment enterprise and vice versa. Thus the business profits of a resident are not necessarily business profits of an enterprise.

Expenditure of an enterprise v. expenditure of a person

On the basis that an enterprise is a part of the person, the expenditure incurred by the enterprise can be said to be expenditure of the person. However, the expenditure incurred by the person may not necessarily be expenditure of the enterprise.

It is interesting to note that Article 7(3) of the DTAAs signed by UK with several countries (Azerbaijan, Bolivia, Guyana, Falkland Islands, Indonesia, Kazakhstan, Lesotho, Mongolia, Norway, Papua New Guinea, Trinidad and Tobago, Uganda, Ukraine, Uzbekistan, Vietnam, Zimbabwe) permit deduction for reasonable allocation of the executive and general administration expenses incurred for the enterprise as a whole.

Continuing on the facts of the Example above, if A Ltd. incurs some general administrative expenses which are not specifically for garment enterprise or cement enterprise, then deduction for such expenses may not be allowed in terms of some of the DTAAs signed by UK. This is because such expenditure would not be considered as incurred by the ‘enterprise’ but by the ‘person’ / ‘resident’.

Reference in OECD Discussions drafts on Attribution of Profits to Permanent Establishment

It will be interesting to take note of a note appearing in the OECD Discussion Draft on Attribution of Profits to Permanent Establishment – Part I. This note reads as follows:

“For the purposes of this Report, references to the ‘enterprise’ or to the ‘enterprise as a whole’ should be interpreted as describing the juridical entity.”

This suggests that for the purpose of discussion drafts the term ‘enterprise’ is to be treated at par with ‘person’ or ‘resident’.

DTAAs not referring to ‘enterprise’

It is interesting to note that the DTAAs signed by USA with certain countries (Canada, Cyprus, Iceland, Indonesia, Israel, Korea, Philippines, Romania, Russia, Ukraine) do not use the word ‘enterprise’. Article 7, 8 and 9 are worded with respect of ‘resident’ or ‘person’. Accordingly, these DTAAs use expressions like ‘permanent establishment of a resident’, ‘related persons’ etc. Accordingly, the issues arising from the term ‘enterprise’ discussed above do not arise for such DTAAs.

Radhakishan Rawal

The above article is adapted from the book The Taxation of Permanent Establishments: an International Perspective, written by Radhakishan Rawal and published by Spiramus Press. For further information and to order the book click here .

Article Added Saturday, 20 January 2007 | 6852 Hits

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