Leased Equipment: When Does a Permanent Establishment Exist?

As in most cross-border commercial transactions, the tax position of a lessor that is resident in one country but leases equipment to a lessee in another country will depend on whether the lessor has a permanent establishment in the latter through which the lessor's business is being carried on. A large number of OECD countries have reserved the right to tax equipment rentals as if they were royalties. Where that is the case, the absence of a permanent establishment in the source country will result in the rental income being subject to a withholding tax on the gross rental revenue, rather than to income tax that would otherwise be levied at normal rates on the net amount of income attributable to a permanent establishment. This article examines the current state of the law in respect of the requirements for the existence of a permanent establishment, with specific reference to the relevant issues relating to cross-border operational lease arrangements, and it reviews the ways in which these requirements are gradually changing.