ARTICLE 5 　　　　　　　　　　　Permanent Establishment 　　This Article defines the term "permanent establishment". This definition is significant for several articles of the Convention. The existence of a permanent establishment in a Contracting State is necessary under Article 7 (Business Profits) for the taxation by that State of the business profits of a resident of the other Contracting State. It can also be a condition for the imposition of the branch tax under Article 14 (Permanent Establishment Tax). Since the term "fixed base" in Article 15 (Independent Personal Services) is understood by reference to the definition of "permanent establishment", this Article is also relevant for purposes of Article 14. Articles 10, 11 and 12 (dealing with dividends, interest, and royalties and fees for included services, respectively) provide for reduced rates of tax by the source State on payments of these items of income to a resident of the other State only when the income is not attributable to a permanent establishment or fixed base which the recipient has in the source State. 　　This Article differs in several significant respects from the U.S. and OECD Model provisions, principally by requiring a lesser nexus with a country before a permanent establishment is determined to exist there. This Article is similar in many respects to Article 5 of the U.N. Model, and to the permanent establishment definition in U.S. treaties with some other developing countries. 　　Paragraph 1 provides the basic definition of the term "permanent establishment". As used in the Convention, the term means a fixed place of business through which the business of an enterprise is wholly or partly carried on. 　　Paragraph 2 contains a list of fixed places of business (or in the case of subparagraph (l), an activity) which will constitute a permanent establishment. The list is illustrative and nonexclusive. According to subparagraphs (a) through f) of paragraph 2, the term permanent establishment includes a place of management, a branch, an office, a factory, a workshop, and a mine, quarry or other place of extraction of natural resources. These are all found in the U.S. Model. 　　Subparagraphs (g), (h), and (i) provide that an enterprise's warehouse which provides storage facilities to others, a farm or similar agricultural facility, and a store or other sales outlet also constitute permanent establishments. While these are not specifically provided for in the U.S. Model, as "fixed places of business through which the business of an enterprise is carried on" they are fully consistent with the principles of the Model, and are, therefore, implicitly contained within the permanent establishment definition in the Model. 　　Under subparagraph (j), a drilling rig or other installation or structure used for the exploration or exploitation of natural resources constitutes a permanent establishment only if the facility is used for an aggregate period exceeding 120 days in a twelve-month period. (See explanation below of Ad Article 5 of the Protocol for a description of the rule applicable when the 120 day time period extends over two taxable years.) 　　Subparagraph (k) provides rules to determine when a building site or a construction, assembly or installation project constitutes a permanent establishment. Only if the site, project, etc. lasts for more than 120 days in a twelve-month period does it constitute a permanent establishment. The time spent on supervisory activities connected with the project or activity is included in determining whether the 120-day test has been met. A series of construction sites or projects are to be combined for purposes of applying the time threshold test. The 120-day period begins when work physically begins in a Contracting State. (See explanation below of Ad Article 5 of the protocol for a description of the rule applicable when the 120 day time period extends over two taxable years.) 　　Subparagraph (l) provides the rule for determining the conditions under which the activity of furnishing services, through employees or other personnel, constitutes a permanent establishment. These rules apply only to the provision of services which are not considered to be "included services", as the term is defined in Article 12 (Royalties and Fees for Included Services). Under the subparagraph, the furnishing of services gives rise to a permanent establishment if either the activity continues for an aggregate of more than 90 days in a twelve month period, or the services are performed for a person related to the enterprise providing the services. In the latter case, no time threshold test must be met for a permanent establishment to exist. The determination of whether persons are related for purposes of this test is made in accordance with the rules of Article 9 (Associated Enterprises). Under the U.S. Model such activities would constitute a permanent establishment only if they are exercised through a fixed place of business or by a dependent agent. (See explanation below of Ad Article 5 of the Protocol for a description of the rule applicable when the 90 day time period extends over two taxable years.) 　　Paragraph I of the Protocol (Ad Article 5) provides a rule which applies with respect to subparagraphs; (j), (k) and (1) of paragraph 3, all of which include time tests for the existence of a permanent establishment. The Protocol rule deals with cases in which the time threshold specified in the particular subparagraph has been met, and that time period extends over two taxable years. The Protocol article states that a permanent establishment will not be considered to exist in any year in which the facility is used or the activity is carried on for a period of less than 30 days in that year. A permanent establishment will exist in the other taxable year and the enterprise will be subject to tax in that year, in accordance with the provisions of Article 7 (Business Profits), but only with respect to income arising in that other year. 　　For example, subparagraph (l) provides that a U.S. enterprise will have a permanent establishment in India if it provides the services of its employees in India for a period of more than 90 days in a 12-month period. If employees are performing services in India from December 20, 1989 through March 20, 1990, that activity will constitute a permanent establishment because it continues for 91 days in a twelve-month period. Since the 91 days span two calendar years and fewer than 30 days are in one of those years, absent the rule in Ad Article 5 of the protocol, there would be a permanent establishment in both years. Under the Ad Article 5 rule, while the period from December 20 through December 31, 1989 would be counted to determine that the 90 day threshold test has been net, for purposes of subjecting the enterprise to tax a permanent establishment will be deemed to exist only in 1990. Thus, there will be no Indian tax on the income attributable to services performed in 1989, and if the enterprise performs similar services in India during 1989 independent of the permanent establishment, the U.S. enterprise will not be subject to Indian tax on any income attributable to those services under the limited force of attraction rule of subparagraph (c) of paragraph 1 of Article 7. Paragraph 3 contains exceptions to the general rule of paragraph 1 that a fixed place of business through which a business is carried on constitutes a permanent establishment. The paragraph lists a number of activities which may be carried on through a fixed place of business, but which, nevertheless, will not give rise to a permanent establishment. The use of facilities solely for storage, display or occasional delivery of merchandise belonging to an enterprise will not constitute a permanent establishment of that enterprise. The maintenance of a stock of goods belonging to an enterprise solely for the purpose of storage, display, or occasional delivery, or solely for the purpose of processing by another enterprise will not give rise to a permanent establishment of the first-mentioned enterprise. The maintenance of a fixed place of business solely for purchasing goods or collecting information for the enterprise, or solely for activities that have a preparatory or auxiliary character for the enterprise such as advertising, the supply of information, or scientific activities, will not constitute a permanent establishment of the enterprise. A combination of these activities will not give rise to a permanent establishment. The use of facilities or the maintenance of a stock of goods solely for regular delivery of goods or merchandise may, however, under the Convention, constitute a permanent establishment since, unlike the U.S. Model, it is not specifically excluded. 　　Paragraphs 4 and 5 specify when the use of an agent will constitute a permanent establishment. Paragraph 4 specifies three conditions in which a dependent agent will constitute a permanent establishment. Only the first of these is found in the U.S. Model. Under subparagraph 4(a), a dependent agent of an enterprise of a Contracting State will give rise to a permanent establishment of the enterprise in the other Contracting State, if the agent has and habitually exercises in that other State an authority to conclude contracts in the name of that enterprise, and his activities are not limited to those activities specified in paragraph 3 which would not constitute a permanent establishment if carried on by the enterprise through a fixed place of business. 　　Under subparagraph 4(b), even if the agent has no authority to conclude contracts, he will give rise to a permanent establishment for the enterprise if he habitually maintains a stock of goods or merchandise in the other State on behalf of the enterprise and regularly makes deliveries from that stock, and there have been some additional activities carried on in that other State on behalf of the enterprise which have contributed to the sale. It is not necessary that these sales activities be carried out by the agent. They may be carried out by the enterprise itself or by another agent. 　　Subparagraph 4(c) contains a rule not found in other U.S. treaties. It provides that an agent who habitually secures orders wholly or almost wholly for an enterprise of a Contracting State will constitute a permanent establishment of the enterprise in the other Contracting State. Diplomatic notes exchanged at the time of the signing of the Convention explain that in order for an agent to be treated as habitually securing orders wholly or almost wholly for the enterprise all of the following tests must be met: 　　1. The agent frequently accepts orders for (goods or merchandise on behalf of the enterprise. 　　2. Substantially all of the agent's sales-related activities in the other Contracting State consist of activities for the enterprise. 　　3. The agent habitually represents to persons offering to buy goods or merchandise that acceptance of an order by the agent constitutes the agreement of the enterprise to supply goods or merchandise under the terms or conditions specified in the order. 　　4. The enterprise takes actions that give purchasers the basis for a reasonable belief that such person has authority to bind the enterprise. Under paragraph 5, as a general rule, an enterprise will not be deemed to have a permanent establishment in a Contacting State merely because it carries on business in that State through an independent agent, including a broker or general commission agent, if the agent is acting in the ordinary course of his business. If, however, the agent's activities are devoted wholly or almost wholly on behalf of the enterprise, and transactions between the agent and the enterprise are on other than an arm's length basis, the agent will not be considered an independent agent. 　　Paragraph 6 clarifies that a company which is a resident of a Contracting State will not be deemed to have a permanent establishment in the other Contracting State merely because it controls, or is controlled by, a company that is a resident of that other Contracting State, or that carries on business in that other Contracting State. The determination of whether or not a permanent establishment exists will be made solely on the basis of the factors described in paragraphs 1 through 5 of the Article. Whether or not a company is a permanent establishment of a related company, therefore, is based solely on those factors and not on the ownership or control relationship between the companies. ARTICLE 6 Income from Immovable Property (Real Property) 　　Paragraph 1 provides that income of a resident of a Contracting State derived from real property situated in the other Contracting State may be taxed in the Contracting State which the property is situated. The paragraph specifies that income from real property includes income from agriculture and forestry. This Article does not grant an exclusive taxing right to the situs State, but merely grants it the primary right to tax. The Article does not impose any limitation in terms of rate or form of tax on the situs State. As clarified in paragraph 3, the income referred to in paragraph 1 means income from any use of real property, including, but not limited to, income from direct use by the owner and rental income from the letting of real property. 　　Paragraph 2 defines the term "immovable property", which, as is made clear in the title to the Article and in paragraph 1, is to be understood to have the same meaning as the U.S. statutory term "real property". The term is to have the same meaning that it has under the law of the situs country. 　　Paragraph 4 specifies that the basic rule of paragraph 1 (as elaborated in paragraph 3) applies to income from real property of an enterprise and to income from real property used for the performance of independent personal services. This clarifies that, notwithstanding the requirements of Articles 7 (Business Profits) and 15 (Independent Personal Services) that income is taxable only if attributable to a permanent establishment or fixed base, respectively, the situs country may tax the real property income of a resident of the other Contracting State even in the absence of a permanent establishment or fixed base in the situs State. 　　The provision in the U.S. Model for a binding election by the taxpayer to be taxed on real property income on a net basis was not included in the Convention. Both Contracting States provide for net basis taxation of such income under internal law, and, therefore, an election provision is not needed. ARTICLE 7 Business Profits 　　This Article provides the rules for the taxation by a Contracting State of the business profits of an enterprise of the other Contracting State. The general rule is found in paragraph 1, that business profits (as defined in paragraph 7) of an enterprise of one Contracting State may not be taxed by the other Contracting State unless the enterprise carries on business in that other Contracting State through a permanent establishment (as defined in Article 5 (Permanent Establishment)) situated there. Where that condition is met, the State in which the permanent establishment exists may tax the income of the enterprise, but only so much of the income as is attributable to 　　(a) that permanent establishment; 　　(b) sales in that State of goods or merchandise of the same or similar kind as those sold through that permanent establishment; or 　　(c) other business activities carried on in that State of the same or similar kind as those effected through that permanent establishment. This limited force of attraction rule is similar to the rule in Article 7 of the U.N. Model. The rule in Article 7 of the U.S. Model is different, limiting the taxation of business profits to income attributable to that permanent establishment. 　　Paragraph 2 provides rules for the proper attribution of business profits to a permanent establishment. It provides that the Contracting States will attribute to a permanent establishment the profits which it would have earned had it been an independent entity, engaged in the same or similar activities under the same or similar circumstances and dealing wholly at arm's length with the enterprise of which it is a permanent establishment and other enterprises controlling, controlled by, or subject to the same control as that enterprise. The computation of the business profits attributable to a permanent establishment under this paragraph is subject to the rules of paragraph 3 for the allowance of expenses incurred for the purposes of earning the income. The profits attributable to a permanent establishment may be from sources within or without a Contracting State. Thus, certain items of foreign source income described in section 864(c)(4)(B) of the Code may be attributed to a U.S. permanent establishment of an Indian enterprise and subject to tax in the United States. The concept of "attributable to" in the Convention is narrower than the concept of "effectively connected" in section 864(c) of the Code. The limited "force of attraction" rule in Code section 864(c)(3), therefore, is not applicable under the Convention. 　　Paragraph 2 concludes with two sentences not found in the comparable provision of the U.S. Model. These sentences state that the profits attributable to the permanent establishment may be estimated on a reasonable basis if the correct amount is either incapable of determination or exceptionally difficult to determine and if the result is in accordance with the principles contained in the business profits article. The United States expects that this rule would be applied only in unusual cases. 　　Paragraph III of the Protocol elaborates on paragraphs 1 and 2 of Article 7, paragraph 4 of Article 10 (Dividends), paragraph 5 of Article 11 (Interest), paragraph 6 of Article 12 (Royalties and Fees for Included Services), paragraph 1 of Article 15 (Independent Personal Services), and paragraph 2 of Article 23 (Other Income). This Protocol paragraph incorporates the principle of Code section 864(c)(6) into the Convention. Like the Code section on which it is based, Paragraph III of the protocol provides that any income or gain attributable to a permanent establishment (or, in the context of Articles 10, 11, 12, 15, and 23, a fixed base as well) during its existence is taxable in the Contracting State where the permanent establishment (or fixed base) is situated even if the payments are deferred until after the permanent establishment (or fixed base) no longer exists. 　　Paragraph 3 provides that in determining the business profits of a permanent establishment, deductions shall be allowed for expenses incurred for the purposes of the permanent establishment. Deductions are to be allowed regardless of where the expenses are incurred. The paragraph specifies that a deduction is to be allowed for a reasonable allocation of expenses for research and development, interest, executive and general administrative expenses and other expenses incurred for the purposes of the enterprise as a whole (or the part thereof which includes the permanent establishment). The language of this paragraph differs from that in the U.S. Model in one significant respect. Under the U.S. Model deductions are not subject to the limitations of local law which may conflict with the general principle of the paragraph. Paragraph 3 in the Convention provides for such deductions in accordance with the provisions of and subject to the limitations of the taxation laws of the State in which the permanent establishment is situated. 　　Indian law limits certain deductions of a permanent establishment with respect to head office expenditures. The deduction of amounts characterized as executive and general administration expenditures (not interest) is capped at five percent of the adjusted total income of the permanent establishment. This limitation was included in the Convention because of the difficulties India has had in verifying claimed deductions for head office expenses and because of the desire of the Indians to avoid litigation on this issue. In practice, the Indian taxing authority does not inquire extensively into deductions that do not exceed the five percent cap. The amount permitted to be deducted is understood by India to be an approximate average of head office executive and general administrative expense incurred by non-Indian companies for the purpose of their permanent establishments in India. However, the rule does not provide absolute certainty that U.S. companies with a permanent establishment in India will be able to deduct from their income subject to Indian tax the entire amount of head office expense incurred for the purpose of the permanent establishment. 　　Ad Article 7 under Paragraph II of the protocol states the understanding of the Contracting States that the deduction of executive and general administrative expenses shall in no case be less than that allowable under the Indian Income Tax Act as on the date of signature of the Convention (September 12, 1989). 　　Paragraph 3 also states that, with two exceptions, a permanent establishment will not be allowed to deduct amounts it pays to the head office, or any other office, of the enterprise as royalties, fees or other similar payments in return for the use of patents, know-how or other rights, as commissions or other charges for specific services performed or for management, or as interest on moneys lent to the permanent establishment. The rule denying deductions for such payments does not apply to amounts paid as reimbursement of actual expenses or as interest on moneys lent to the permanent establishment of a banking enterprise. Such payments made by the head office or any other office of the enterprise to a permanent establishment are similarly treated in determining the permanent establishment's profits. This provision is similar to the rule in Article 7(3) of the U.N. Model. 　　Paragraph 4 provides that no business profits will be attributed to a permanent establishment merely because it purchases goods or merchandise for the enterprise of which it is a permanent establishment. This rule refers to a permanent establishment which performs more than one function for the enterprise, including purchasing. For example, the permanent establishment may purchase raw materials for the enterprise's manufacturing operation and sell the manufactured output. While business profits may be attributable to the permanent establishment with respect to its sales activities, no profits are attributable with respect to its purchasing activities. If the sole activity were the purchasing of goods or merchandise for the enterprise the issue of the attribution of income would not arise, because, under subparagraph 3(d) of Article 5 (Permanent Establishment), there would be no permanent establishment. 　　Paragraph 5 states that the business profits attributed to a permanent establishment are only those derived from its assets or activities. As noted in connection with paragraph 2 of this Article, the Code concept of effective connection, with its limited "force of attraction", is not incorporated into the Convention except to a limited extent as described in connection with paragraph 1 of this Article. 　　Paragraph 6 explains the relationship between the provisions of Article 7 and other provisions of the Convention. Under paragraph 6, where business profits include items of income that are dealt with separately under other articles of the Convention, the provisions of those articles will take precedence over the provisions of Article 7 except where those articles provide otherwise. Thus, for example, the taxation of interest will be determined by the rules of Article 11 (Interest), and not by Article 7, except where, as provided in paragraph 5 of Article 11, the interest is attributable to a permanent establishment, in which case the provisions of Article 7 apply. 　　Paragraph 7 defines the term "business profits" as used in the Convention to mean income derived from any trade or business including income from services other than "fees for included services" as defined in Article 12 (Royalties and Fees for Included Services) and including income from the rental of tangible personal property other than income from the rental of property described in paragraph 3(b) of Article 12. Thus, service income (other than fees for included services) is subject to tax in a Contracting State to the extent provided under Article 7, subject to the principle of paragraph 6, described above. Also, rental income from tangible personal property (other than payments received for the use of, or the right to use, any industrial, commercial, or scientific equipment) is subject to tax in a Contracting State to the extent provided under Article 7. The comparable provision in the U.S. Model provides a general definition which says that the term "business profits" means income derived from any trade or business. The definition in the Convention specifically identifies the residual categories of income from services and tangible personal property as business profits in order to clarify the interaction of Articles 7 and 12. The exclusion from the term "business profits" of fees for included services defined in Article 12 and rental of property described in paragraph 3(b) of Article 12 is intended to apply only in cases where paragraph 6 of Article 12 is inapplicable to such income items. In other words, where such income items are attributable to a permanent establishment in a Contracting State, such items shall be considered business profits to which Article 7 applies. 　　This Article is subject to the saving clause of paragraph 3 of Article 1 of the Convention.Thus, if, for example, a citizen of the United States who is a resident of India derives business profits from the United States which is not attributable to a permanent establishment in the United States, the United States may tax those profits as part of the worldwide income of the citizen, notwithstanding the provisions of this Article under which such income derived by a resident of India is exempt from U.S. tax.