Investing in data centres: understanding Permanent Establishment issues

Corporate Income Tax 

Before investing in data centres, it is crucial to understand the concept of Permanent Establishment (PE) as interpreted by the tax authorities where the data centres have to be located, especially in the context of the digital economy. 

Recently, Italian authorities have adopted an innovative approach to challenging the presence of a PE for foreign companies, as witnessed by the recent Google or Netflix cases.

Indeed, tax authorities may argue that the availability of a network of servers used for providing services to local customers may constitute a PE under the concept of a fixed place of business. This approach marks a shift in the interpretation of PE, reflecting an evolving and increasingly fluid definition. Traditionally, PE has been understood through the lens of physical presence, such as offices or branches. However, the digital economy's growth necessitates new interpretations.

Historically, the definition of PE has been governed by tax treaties between countries, guided by the OECD Tax Treaty Model. With initiatives like BEPS (Base Erosion and Profit Shifting) Actions 1 and 7, the EU Directive Proposal 147 of 2018, and amendments to Article 162 of the Italian legislation, the scope of what constitutes a PE has expanded. The OECD Model Convention now includes exemptions for specific activities, a new definition of dependent agent PE, and an "anti-fragmentation" rule. Furthermore, the concept of Significant Economic Presence (SEP) has emerged, proposing that businesses can have a PE based on their digital and economic presence, even without a physical office.

Despite these changes, the new definitions are not immediately enforceable. They require renegotiation of existing tax treaties and the ratification of the Multilateral Convention (MLI) to implement BEPS measures. This process allows countries to make reservations or opt out of certain provisions, meaning full global consensus is still lacking.

SEP, designed to address tax challenges posed by digital businesses, aims to create a nexus between foreign entities and revenues generated within a country. This concept considers factors such as a user base, local billing, and after-sales services.

Investors must be aware that while SEP and other new PE definitions aim to tax profits of non-resident digital enterprises, these interpretations can significantly impact business operations and tax obligations. 

The recent Italian cases exemplifies the need for companies to carefully evaluate their business models and the potential for PE establishment when investing in a foreign country.

In conclusion, understanding the evolving definitions of PE and SEP is vital for foreign companies, especially in the digital economy, when considering investments in data centres. These changes reflect a broader trend of tax authorities adapting to modern business practices, but they also bring uncertainty and the need for diligent planning and compliance.

For more information, please contact Giuliana Polacco and Andy van Esdonk.