Has the Permanent Establishment Rule Outlived Its Utility in a Digitalized World?

Abstract

This article is written at a critical time when countries across the world are meaning to design effective ways to tackle the international tax challenges posed by digital economy. Although the Organisation for Economic Co-operation and Development’s final report on base erosion and profit shifting Action 1 discusses some of the key challenges, it does not provide concrete solutions or recommendations for world governments to act upon. We note that the traditional international tax rules governing source-based taxation of business profits of foreign enterprises need to be reconceptualised in view of the recent advancements in information and communication technology. This could be done by supplementing the current “physical nexus” rule stipulated in the permanent establishment article of tax treaties with a new nexus to tax based on “significant economic presence”. We recommend two Options that countries can consider while drawing this new nexus.