Digitized Trade and "Permanent Establishment" in Tax Treaties

According to a 2002 study of Rahul Mukherji of the Rajiv Gandhi Institute for Contemporary studies in New Delhi, digitization propelled international trade is eroding the fiscal sovereignty of states. It is Mukherji’s view that unilateral attempts to fix this problem will lead either to tax erosion or to double taxation.

In taxation law, we learned that the primary solution to address the problem of double or multiple taxation for transnational transactions is by way of tax treaty. Crucial to the success of tax treaty mechanism however is the concept of permanent establishment. For purposes of trading or economic activities in the internet (digitized trade, to borrow the words of Mukherji), how do we apply the concept of permanent establishment should the Philippines use tax treaties vis-à-vis digitized trade?

Just to refresh our memory as to meaning of the concept, according to the BIR website (http://www.bir.gov.ph/taxinfo/tax_income.htm), permanent Establishment is defined as a fixed place of business through which the business of the enterprise is wholly or partly carried on. The concept of permanent establishment is used to determine the rights of a Contracting State to tax the business profits of enterprises of the other Contracting State. Under this concept, profits of an enterprise of a Contracting State are not taxable by the other Contracting State, unless the enterprise carries on business through a permanent establishment situated in the other Contracting State.

Here's how I would explain it. The logic behind permanent establishment is that the government will tax the foreign establishment only if it engages on regular transactions within a certain period of time in its territory. If the transaction is not on a regular basis, don’t tax it. How does this correct double or multiple taxation? By taxing only those foreign businesses in the Philippines conducting business on a regular basis for a particular period of time, you don’t unnecessarily expose businesses to double or multiple taxation.

In effect, a taxing jurisdiction like the Philippines, taxes only those “permanent establishments” (those doing business over a period of time as stated in the tax treaty). Their double taxation (taxation in their home State, taxation in the Philippines) is justified because by doing their business in the Philippines for a period of time, they are deemed to be benefiting from the protection of the Philippine government.

The problem with the concept is its dependence on the physical location of the permanent establishment. How do you locate a firm engaged in digitized trade for taxation purposes? Is amazon.com taxable in the Philippines? Is it a permanent establishment?

The Philippines has yet to adopt a concept of permanent establishment that includes digitized trade. It is not a simple adoption by administrative regulation. Tax treaties after all, are by-products of negotiations between States.

The basic question is however, to tax or not to tax. Taxation may be the source from which government creates but as Justice Marshall once said, taxation also has the power to destroy.



















Entry Number 9

Bryan A. San Juan