Introduction

Permanent Establishment (“PE”) is an expression that involves two concepts namely ‘Permanent’ and ‘Establishment’.

Permanence indicates something that lasts long or intending to last forever.

Establishment in business context could be understood as an economic unit which operates in goods or services and is identifiable.

In a PE, the former (permanence) deals with ‘time span/duration’ and the latter (establishment) with the ‘identity’.

A permanent establishment is a fixed place of business through which an undertaking not based in Italy carries out its business in the country.

The fixed place of business is made up of a tangible structure present on a continuous basis in the country: the structure must be made up of people, or must be technological, for example a server, or it must carry out a commercial activity.

Assessing the existence of a PE is imperative since if an enterprise of a contracting state has a PE in other contracting state, then the profits / income of such enterprise as much as attributable to such PE are liable to tax in other contracting state.

The definition of PE included in the tax treaties is therefore crucial in ensuring that a non-resident enterprise must pay a fair portion of income-tax in another State.

With the recent and rapid transformation in the ways the businesses are conducted, it is possible to be heavily involved in the economic life of another country, e.g. by doing business with customers located in that country via the internet etc., without having a taxable presence therein such as substantial physical presence or a dependent agent.

In an era where non-resident taxpayers can derive substantial profits from transactions with customers located in another country without having a taxable presence therein, a number of countries have expressed concerns as to whether the current international standards on which bilateral treaties are based ensure a fair allocation of taxing rights on business profits, especially where the profits from such transactions go untaxed anywhere.

What kind of activities may be performed without creating a taxable presence in Italy?

The existence of a PE of a non-resident taxpayer in Italy has several implications, which may be summarized as follows: In general terms, a foreign company will not be deemed to have a “permanent establishment” in Italy – and therefore not subject to taxation in Italy- if it carries out solely a preparatory or auxiliary activity, even if this activity is carried on through a fixed place of business.

In particular, the Italian law art. 162 co. 4 TUIR (based on article 5 of the OECD Model) contains a list of examples of activities where a “fixed place of business” cannot be deemed to be a permanent establishment of a company resident abroad.

Therefore, a foreign undertaking based in Italy does not qualify as a permanent establishment when:

The new rules based on Italy's 2018 Budget Law 

Effective January 1, 2018, Italy's 2018 Budget Law significantly amended the domestic definition of permanent establishment ("P.E.") and implemented certain O.E.C.D. guidelines set forth under B.E.P.S. Action 1 (Addressing the Tax Challenges of the Digital Economy) and Action 7 (Preventing the Artificial Avoidance of P.E. Status).

The 2018 Budget Law introduced a new concept of Fixed Place P.E. enacted in the context of tax measures for the digital economy.

Under the amended text of Art. 162 (2) of the TUIR, a foreign entity's significant and continuous economic presence in Italy may constitute a fixed base that could give rise to an Italian P.E. even if it does not result in a substantial physical presence.

This new P.E. definition is based on the nexus rules proposed for the digital economy by B.E.P.S. Action 1 and, in particular, on the notion of "significant economic presence," so that nonresident digital companies can trigger taxable presence in a country in ways that are not uncommon in the digital economy.

These include (i) the earning of revenues from customers situated in the country, (ii) the presence of a local digital platform, (iii) the frequency of digital transactions, and (iv) the number of users.

At the same time that this new Digital P.E. concept was introduced into law, Italy introduced a Web Tax, designed to be an alternative to the income tax that applies when a foreign company does not have an Italian P.E.

The Web Tax is a 3% tax on the amount realized (net of V.A.T.) for digital services supplied electronically.

The 2018 Budget Law introduced the so-called anti-fragmentation rules, aimed at preventing foreign companies from splitting up a business into smaller units or using other related legal entities or P.E.'s to benefit from the preparatory or auxiliary exemption.

To this end, the new Article 162 (5) of the TUIR now provides that the exemption from the specific activity does not apply to a fixed place of business that is used or maintained by the foreign enterprise if certain conditions are met:

Conclusion

The definition of PE has been modified to better reflect today's business reality and avoid widespread circumvention of the principle that underlines it.

The amended provision will ensure that a business’ core activities cannot inappropriately benefit from the exception for preparatory and auxiliary activities, and that the PE status will no longer be circumvented via the use of commissionaires or similar structures, or via the fragmentation of activities among different group entities.