Testing the Permanent Establishment Concept

Testing the Permanent Establishment Concept


20 Jul, 2023 10:07 WIB

Jakarta, ideatax -- With the development of business and information technology, the concept of a permanent establishment is increasingly recognized today. However, did you know that the concept of permanent establishment was already known for more than 130 years ago?


Initially, the concept of permanent establishment was developed by the Kingdom of Prussia to avoid double taxation between cities in Prussia. Furthermore, through the double taxation avoidance agreement between Austria - Hungary and Prussia (Betriebsstatten) in 1899, the concept of permanent establishment was introduced internationally (Rao, 2023). This concept then developed rapidly. In fact, in 1928, the League of Nations developed a model to address cross-border double taxation and prevent tax avoidance (Kobetsky, 2011).


The UN defines a permanent establishment as a fixed place of business through which the business of an enterprise is wholly or partly carried on (UN, 2017). The same definition is provided by the OECD in the Articles of The Model Convention with Respect to Taxes on Income and on Capital (OECD, 2017).


The Indonesian domestic regulation defines a permanent establishment as a form of business used by individuals who do not reside in Indonesia, individuals who are in Indonesia for not more than 183 days within a period of 12 months, and entities that are not established and not domiciled in Indonesia to conduct business or carry out activities in Indonesia. We can find this definition in Article 2 paragraph (5) of Law Number 7 of 1983 concerning Income Tax as amended by Law Number 7 of 2021 concerning Harmonization of Tax Regulations.


Based on the above definition, there are at least six conditions that must be met to establish a permanent establishment: (i) there is a permanent place of business (place of business test); (ii) the place of business is established in a certain location (location test); (iii) the tax subject must have the right to utilize the place of business (right use test); (iv) the use of the place of business must be permanent or for a period exceeding a certain period of time (permanent test); (v) the activity conducted through the business place must be a business activity as the definition of business activity regulated in domestic and tax treaty regulations (business activity test); (vi) the business form is used by individuals who do not reside in Indonesia or reside in Indonesia for less than one hundred and eighty-three days in one year (time test).


If the six conditions mentioned are not met, then the business form cannot be formed.


Place of Business Test

A permanent establishment is considered to fulfill the place of business test if the establishment occupies a place, facility or installation to conduct its business regardless of whether it is used solely for that purpose. Article 2 paragraph (5) of the Income Tax Law provides a broad definition related to place of business, which includes:

  • place of management,

  • branch company, representative office,

  • office building,

  • factory,

  • workshop,

  • warehouse,

  • space for promotion and sales,

  • mining and excavation of natural resources,

  • petroleum and natural gas mining areas,

  • construction, installation or assembly projects


An example of this place of business test: when a Dutch company operates an underground pipeline in Germany to deliver petroleum products to its customers. Although the entire operation of the pipeline was in the Netherlands, the existence of the underground pipeline created a permanent establishment in Germany (Darussalam & Ngantung, 2017).


Location test

A business activity is considered to comply with the location test if the business activity occupies or is located at a certain geographical point. The location test is also often used as a measure to determine which country has the right to tax an activity (Darussalam & Ngantung, 2017).


This kind of opinion is supported by Klaus Vogel who states that there is a strong connection between the location of the business and a certain geographical point in determining the permanent establishment (Reimer & Rust, 2022).


Based on this time test, a train that crosses borders between countries cannot create a permanent establishment because it does not have a specific geographical location. However, a train ticket sales point located in a specific geographical location can certainly give rise to a permanent establishment.


The Right Use Test

Right use test is a test to determine whether an entity has the right to use or utilize a place of business regardless of whether the place is purchased or leased. Thus, if a business activity occupies a certain location and has the right to use the location, the business form can still be formed.


Permanent test

A place of business is considered permanent if it is used to run a business that is regular rather than situational (temporary). In addition, a place of activity is said to be permanent if the place of activity is intended for activities that take place continuously without knowing when it will stop (indefinitely continuing). For example, a court in Antwerp ruled that a foreign restaurant in the Netherlands that was only open when the flower show arrived was considered to have a permanent form of business because it met the permanent test (Darussalam & Ngantung, 2017).


Business test

As mentioned earlier, the business activity test is intended to test whether a business activity conducted through a particular place of business is a business activity as regulated in domestic and tax treaty regulations.


OECD Tax Treaty model regulates that "the term business, includes the performance of professional services and other activities of independent character". Thus, permanent establishment is not merely a business activity conducted in a particular geographical location. More than that, a permanent establishment can also be formed when there are professional services performed by certain entities.


This regulation has basically been accommodated by our Income Tax Law. Article 2 paragraph (5) letter m of the Income Tax Law, among others, regulates that one of the things that can form a permanent establishment is the regulation of services in any form by another person, as long as it is carried out for more than sixty days within a period of twelve months.


Time test

The time test is a series of tests aimed at determining whether a business activity has conducted a business activity within a certain period of time required in the establishment of a permanent establishment.


In our domestic regulations, it is regulated that if a private person conducts business in Indonesia but is in Indonesia for less than one hundred and eighty-three days in one year within a period of twelve months, it is deemed that a permanent establishment has materialized. If the individual is in Indonesia for more than one hundred eighty-three days in a twelve-month period, the individual automatically changes his status to a domestic tax subject.


In addition, the income tax law also regulates that if an employee of an entity outside the Indonesian tax jurisdiction provides services in Indonesia for a period of less than sixty days in twelve months, it is deemed that a permanent establishment has been established.


Permanent Establishment Exception

Based on the aforementioned, it is clear that to establish a permanent establishment, several conditions are required to be met first. However, there are several conditions that do not give rise to a permanent establishment as regulated in Article 5 of the OECD model as follows:

  • the use of facilities that are solely intended to store or display merchandise of foreign tax subjects;

  • management of a company's property which is solely intended for storage, display or delivery;

  • management of a company's property which is solely intended for further processing;

  • management of a place of business which is solely intended to carry out activities that are supporting;

  • management of a place of business which is solely intended to purchase merchandise or collect information.


That is a little explanation about testing a permanent business form. If you need further explanation, Ideatax is ready to help.



Darussalam, & Ngantung, Y. W. (2017). Bentuk Usaha Tetap. In Darussalam, & D. Septriadi, Perjanjian Penghindaran Pajak Panduan, Interpretasi, dan Aplikasi (pp. 109-150). Jakarta: DDTC.

Kobetsky, M. (2011). History of tax treaties and the permanent establishment concept. In International Taxation of Permanent Establishments Principles and Policy (pp. 106-151). Cambridge: Cambridge University Press.

OECD. (2017). Articles of The Model Convention With Respect To Taxes On Income And On Capital . Paris: OECD .

Rao, S. (2023, July 02). Austria Prussia Tax Treaty. Retrieved from https://sites.google.com/view/austriaprussiataxtreaty1899

Reimer, E., & Rust, A. (2022). Klaus Vogel on Double Taxation Conventions. Singapore: Wolters Kluwer.

UN. (2017). United Nations Model Double Taxation Conventions. Washingtom DC: UN.