Pakistan’s tax code has witnessed significant changes, introduced through the Finance Act 2018 (effective from 1 July 2018), which affect the tax position of permanent establishments (PE). This article describes notable developments with regard to the scope of PE and the determination of its tax liability.
BEPS Action 7
Dependent agent PE
The definition of PE has been amended to address the artificial avoidance of PE status through commissionaire and undisclosed agent arrangements, pursuant to BEPS Action 7. The amendment seeks to include not only contracts in the name of the person but also contracts for transferring or granting the right to use property, or the provision of services by the person where the agent habitually concludes contracts or plays the principal role in the conclusion of contracts that are routinely finalised without material modification. It has also been clarified that “independent agent” does not include the person acting exclusively or almost exclusively on behalf of the person with whom it is an associate – thus limiting the scope of exclusion for independent agents.
Cohesive business operations
Amendments to the definition of PE, rules for determining Pakistan source income, and withholding tax provisions together have the effect of taxing the cohesive business operations (CBO) of non-residents as income of PE (commonly known as turnkey or composite arrangements). CBO are defined to include an overall arrangement for the supply of goods (including import in the name of an associate or any other person regardless of the place where the title is transferred), installation, construction, assembly, commission, guarantees or supervisory activities whereby all or principal activities are undertaken by the person or their associate. Taxation of such arrangements has historically been a contentious issue in Pakistan. In the past, courts have taken a source-based view, exempting offshore supply where the title to goods is transferred to a customer outside Pakistan. Taxing offshore supply on the premise of CBO may give rise to a new controversy, and its implementation may be challenged. It is further noted that in the case of contracts undertaken by a consortium of unrelated members, the activities of each member may not qualify as CBO. Nevertheless, the avoidance of double taxation treaties will continue to have an overriding effect, and their implications need to be considered in each case.
Minimum tax for a service PE
Payments received by a PE against services rendered or provided is subject to a deduction of tax at source (rates: 8% for filers or 14% for non-filers). Previously, the tax deducted by the payer was treated as an advance payment of the provider’s corporate tax liability. A recent amendment has designated such tax deduction as the minimum payment of the PE’s corporate tax liability. Effectively, the corporate tax liability of a service PE is now the higher amount of (a) corporate tax at 29% on taxable income; or (b) tax deducted at source at 8% or 14%; or (c) alternative corporate tax at 17% of accounting profits. This development aims to align the taxation of a service PE with resident service providers.
As an exception to this rule, certain specified services of PE shall be subject to minimum tax at 2% of gross turnover, subject to fulfilling additional requirements including a tax audit.