Turbine Commissioning and Permanent Establishment Risk
Alpha GmbH, resident in Country A, signs a €12 million contract with a Country B utility to supply and commission a turbine. Commissioning is scheduled for 190 days, split into two phases separated by a 30-day weather shutdown. Alpha's engineer is present in Country B throughout and may approve minor change orders up to €50,000. Alpha's Country B subsidiary provides warehouse space and local payroll administration; subsidiary staff do not negotiate, conclude contracts, or maintain a stock of goods. The Country B tax authority asserts a construction permanent establishment and a dependent-agent permanent establishment, and proposes to tax 35% of the contract's profit. Alpha argues that the 30-day gap resets the construction PE clock and that the engineer's authority is merely ancillary. Assume the applicable treaty defines a construction PE only where the site or project lasts more than nine months, and treats connected projects as one project if commercially inseparable. The agency clause requires habitual conclusion of contracts or a decisive role in their conclusion.
1. Determine whether Alpha has a construction PE, a dependent-agent PE, or both. Address the 30-day gap, connected projects, and the engineer's change-order authority.
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Construction PE. The assumed treaty threshold is more than nine months. Alpha's on-site commissioning is 190 days, roughly 6.2 months. Even if the two phases are treated as one connected project because they are commercially inseparable, the total on-site period remains 190 days. The 30-day shutdown therefore does not create a PE, and the tax authority gains nothing by aggregating the phases. The threshold is not met.
Dependent-agent PE. The subsidiary provides storage and payroll only. Its staff do not negotiate, conclude contracts, or hold stock. Those activities do not satisfy the agency clause. The engineer can approve minor change orders up to €50,000, but approving variations to an existing contract is not habitually concluding contracts or playing a decisive role in their conclusion. That authority is ancillary to the installation function. A fixed-base PE could in theory arise from prolonged presence, but the facts do not describe a service PE clause or a fixed place of business beyond the construction site.
Conclusion. On the stated facts Alpha has no PE. The 35% profit allocation is therefore unsupported. The result would change only if the contract were extended beyond nine months or if the engineer could bind Alpha to new contracts.
2. If a PE were found, explain how profit should be attributed and why a 35% contract-profit allocation is unlikely to be defensible.
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A PE must be taxed on the profit it would have earned at arm's length as a separate enterprise. The analysis starts with a functional and factual review: what functions does the Country B PE perform, what assets does it use, and what risks does it assume? Here the PE would perform installation, commissioning, quality control, and minor variation approval. Procurement, contract negotiation, financing, and overall project risk appear to sit in Country A.
A proper attribution would first reward routine installation and supervision functions, often by a cost-plus return supported by comparables. It would then consider whether any residual profit belongs to the PE for risk management or contract negotiation, which the facts do not support. A flat 35% of contract profit ignores the functional split and double counts head-office procurement or engineering value. It is also inconsistent with the limited €50,000 variation authority.
The tax authority would need comparables and a documented allocation of revenues and costs to the PE. Alpha should prepare a contemporaneous functional analysis, contract map, and benchmarking study. If no PE exists, no profit is attributable; the subsidiary's storage and payroll services should be tested separately under transfer pricing rules.