Expanding/Establishing an e-commerce business in the EU
Be aware of the ‘virtual’ permanent establishment and other fiscal pitfalls

Expanding/Establishing an e-commerce business in the EU
Be aware of the ‘virtual’ permanent establishment and other fiscal pitfalls

E-commerce businesses in the EU are often incorporated in a low tax jurisdiction and distribute products in all EU member states. It does not surprise that such a structure is a thorn in the side of high-tax jurisdictions, in particular when these jurisdictions are the core market for the e-commerce business.

This paper will provide a concise overview whether profits of an e-commerce business can be taxed in a state where the e-commerce business is not incorporated. The general rule is that profits of a business are only subject to tax in the state where it is incorporated. A state can only tax the profits of a non-resident business, if the non-resident business has a so called ‘permanent establishment’ in this specific state. In the case of only selling products online to a specific state, the conditions of a ‘permanent establishment’ are normally not fulfilled so that the state to where the products are sold online has no right to tax the profits of such transactions.

1. Permanent Establishment as per Article 5 OECD Model Tax Convention

The tax treatment of cross-border commerce is the subject of bilateral tax treaties, (Agreements for the Avoidance of Double Taxation, ‘DTAs’) which are negotiated versions of the OECD Model Tax Convention.

According to Article 7 of the OECD Model Tax Convention concerning the taxation of business profits, the source country may tax the profits arising from commercial activities carried out within its borders by a foreign entity through a substantial physical presence in the source country.

However, to justify source taxation, such substantial physical presence must reach the level of a permanent establishment as defined in Article 5 of the OECD Model Tax Convention by satisfying the following three prerequisites, namely

  • the existence of a distinct place, such as premises, or in certain instances, machinery or equipment (‘place-of-business’ test),
  • that this place of business must be ‘fixed’, i.e. it must be established with a certain degree of permanence (‘permanence test’),
  • and that the business must be carried on through this fixed place of business. This means usually by personnel of the foreign entity or by personnel who is dependent on the foreign entity (business-activities test).

If the physical presence does not reach the level required by the OECD Model Tax Convention by satisfying these requirements, the source state is not entitled to charge income tax on the profits arising from the international transaction, rather the residence country of the profit making company will have the right to tax the profits of its resident.

An e-commerce business registered in a low tax jurisdiction can normally avoid a ‘permanent establishment’ as defined in Article 5 OECD Model Tax Convention in other countries where it is selling its products.

1.1 The OECD’s approach on the definition of a ‘virtual’ permanent establishment (PE)

The OECD’s Committee on Fiscal Affairs issued a ‘Clarification on the application of the permanent establishment definition in e-commerce: Changes to the Commentary on the model tax convention on Article 5’. In the Clarification it is distinguished between

  • computer equipment, which may be set up at a location so as to constitute a PE under certain circumstances,
  • and the data and software which is used by, or stored on that equipment.

As per the para 42.2 of the Clarification, a website which is a combination of software and electronic data, does not in itself constitute tangible property. Therefore, it does not have a location that can constitute a place of business as there is no ‘facility such as premises or machinery or equipment’.

On the other hand, the server on which the website is stored and through which it is accessible, is a piece of equipment having a physical location and such location may thus constitute a ‘fixed place of business’ of the company that operates that server.

To sum up, as per the OECD definition, the place where the server is located could constitute a PE of the company. Whereas, the presence or availability of a website in a certain state does not constitute a fixed place of business by itself.

1.2 The Spanish tax authorities’ approach to a ‘virtual’ PE (‘Dell-case’)

In the ‘Dell’ case a Spanish commissionaire subsidiary was categorized by the Spanish tax authorities as PE of its Irish holding company. The Spanish tax authorities concluded and Spanish courts affirmed that sales made by the non-resident entity Dell Ireland through a website which targeted the Spanish market and which was maintained by staff of the Spanish affiliate Dell Spain was sufficient for the conclusion of a PE in Spain. The consequence was that all the sales made by the non-resident Irish company in Spain (minus commissions paid to the Spanish affiliate and other related allocable expenses) were attributed to the Spanish affiliate PE.

2. Introduction of a new digital service tax (‘DST’) in the EU

The EU member states are working on an EU-wide solution to tax profits of e-commerce businesses in each member state. At the same time, some member states are working on a taxation right on a national level, notably France and Spain. In both states, however, only draft laws and proposals are circulating.

On 21 March 2018, the European Commission submitted 2 legislative proposals with the aim that digital business activities are taxed EU-wide.

Proposal 1: Common reform of EU’s existent corporate tax rules for digital activities

This proposal would enable member states to tax profits that are generated in their territory, even if a company does not have a physical presence there. A digital platform shall be deemed to have a taxable ‘digital presence’ or a ‘virtual’ permanent establishment in a member state if it fulfils one of the following criteria:

  • it exceeds a threshold of €7 million in annual revenues in a member state;
  • it has more than 100,000 users in a member state in a taxable year;
  • over 3000 business contracts for digital services are created between the company and business users in a taxable year.

The new rules shall also change how profits are allocated to member states in a way which better reflects how companies can create value online: for example, depending on where the user is based at the time of consumption.

Proposal 2: An interim tax on certain revenue from digital activities

Unlike the common EU reform of the underlying tax rules, the tax would apply to revenues created from certain digital activities which escape the current tax framework entirely.

This system would apply only as an interim measure, until the comprehensive reform has been implemented and has inbuilt mechanisms to alleviate the possibility of double taxation.

A tax of 3% would apply to revenues created from activities where users play a major role in value creation and which are the hardest to capture with current tax rules, such as those revenues:

  • created from selling online advertising space;
  • created from digital intermediary activities which allow users to interact with other users and which can facilitate the sale of goods and services between them;
  • created from the sale of data generated from user-provided information.

Tax revenues would be collected by the member states where the users are located, and would only apply to companies with total annual worldwide revenues of €750 million and EU revenues of €50 million or more.


The Ministries of Finance of the EU member states are in the phase of reviewing the proposals and debates are ongoing. Whereas Spain is already in the phase of proposing national legislation for taxation of digital services – modelled on the Proposal 2 of the European Commission – and would most probably welcome EU-wide implementation, Germany for example is generally opposed. Therefore, it remains to be seen whether in Spain and/or EU-wide the DST will be introduced.


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