The Organization for Economic Co-Operation and Development (the “OECD”), of which the United States is an original member, has produced a Model Tax Convention on Income and on Capital (the “OECD Model Treaty”).
Article 5 of the OECD Model Treaty defines a permanent establishment (a “PE”). A PE is a concept used to determine the right of one treaty country to tax the profits of a resident of an enterprise of the other treaty country.
To assist persons in understanding and applying the OECD Model Treaty, the OECD also publishes commentary (the “OECD Commentary”) on the model treaty. One issue specifically addressed in the OECD Commentary on Article 5 is the extent to which engaging in electronic commerce may result in a PE. See Paragraphs 42.1 to 42.10 of the OECD Commentary on Article 5.
In general, the OECD Commentary states that a web site does not itself involve any tangible property, and thus cannot constitute a PE. Paragraph 42.2. In contrast, the server on which a web site is stored and through which it is accessible is a piece of equipment having a physical location, which may be fixed and thus constitute a PE.
This distinction between a web site and the server on which the web site is stored and used is important since the enterprise that operates the server may be different from the enterprise that carries on business through the web site. In fact, an enterprise carrying on a business through a web site will often do so on a server owned by an unrelated Internet service provider (“ISP”). A contract for such hosting services does not typically result in the server and its location being at the disposal of the enterprise carrying on a business through the web site.
In such a case, the enterprise does not have any physical presence at the location where the server is located since the web site is not tangible and the server is not at the disposal of the enterprise. The OECD Commentary also notes that it would be very unusual for the ISP to be deemed to constitute a PE of the enterprise carrying on a business through a web site hosted on the ISP’s servers. Paragraph 42.10. Generally, the ISP will lack authority to conclude contracts in the name of the enterprise conducting the web site business (and will not regularly conclude such contracts) and will constitute an independent agent acting in the ordinary course of its business. The result may be different if the enterprise carrying on business through a web site has the server at its disposal because, for example, it owns (or leases) and operates the server. In such a case, the place where the server is located may constitute a PE.
It is important to note that the rules discussed above apply only in the treaty context, i.e., where the enterprise operating the website and the ISP are located in countries that have concluded an income tax treaty based on the OECD Model Treaty. Entirely different rules can apply if there is no treaty to rely upon.