Permanent Establishment from Construction Site in Italy

Italian legislation on permanent establishment: the special case of a construction site

For a permanent establishment to be constituted, there are a series of conditions that must be met and that need to be verified in each single case. In particular, according to Article 162 of TUIR (Italian Tax Consolidated Text), in order to give rise to a permanent establishment in Italy the foreign enterprise must have a fixed place of business in the territory of the State through which the business is eventually carried on and that contributes to profit making.

The special case of a construction site or assembly or installation project is regulated by Paragraph 3 of Article 162 of TUIR, where it is stated that these activities «shall be considered a permanent establishment only if such a site, project or activity has a duration of more than three months», thus setting a condition based on time duration.

Indeed, in the cases the so-called permanence test (i.e., the place of business should have a certain “degree” of permanence), is replaced by the duration test: only when exceeding the 3-moths threshold a construction site can be qualified as a permanent establishment.

In order to determine the ab initio period of three months, it should be noted that the period is being computed from the beginning of any preparatory activity related to the opening of a construction site.

Furthermore, the Italian Article 162 of TUIR, even though modeled on Article 5 of the OECD Model Tax Convention, expressly provides that also supervisory activities connected with a construction site or installation project must be taken into account for a PE to be qualified as such.

Case-law on construction site as PE

According to a former jurisprudential guideline of the Italian Supreme Court that recognized the existence of a permanent establishment in relation to a construction site of a non-resident, it was declared that in determining whether a certain activity shall give rise to a permanent establishment, that can be assumed every time a particular activity is non temporary, considering the object of the contract and any other useful element.

The latter and fundamental Judgment No. 28059/2017 of the same Court, however, rejected the interpretation set up by the Italian Revenue Agency, according to which a construction site could be considered a priori as a permanent establishment whenever the period of at least twelve months (with reference to the bilateral Convention enforceable to the case) was overcome, without any further regard to the objective and subjective requirements needed. More specifically, the Supreme Court has stated that in order to be considered as a permanent establishment, a construction site or installation or assembly project must be relevant with respect to the activity from which the subsequent profit arises – in the specific case of law, the foreign enterprise with staff working on construction sites of an Italian general contractor with minimum equipment, did not give rise to a permanent establishment.

As consequently reaffirmed by the Italian Supreme Court (Court Order No. 11429 of 2019), the interpretation of the concept of permanent establishment set out by the Italian Jurisprudence is based  on two fundamental elements: the fixed place of business, from an objective point of view, and the carrying on of the business. These elements must be verified by the judge in each single case.

Nevertheless, the Italian Corte di Cassazione has recently specified (cf. Judgment No. 32078/2018), that for a foreign enterprise to be taxable on the existence of a permanent establishment in Italy, it is immaterial that the PE is effectively a source of income; indeed it is sufficient that the enterprise has a fixed place of business through which carries on partly or wholly its business.

The same Court (cf. Judgment No. 23984/2016; Judgment No. 30140/2019) has also stated that according to the Italian Constitution, international conventions that have been ratified in Italy shall prevail over each domestic rule, as affirmed also in Article 75 of D.P.R. No. 600/1973 and in Article 169 of TUIR, in view of their aim of avoiding double taxation.

OECD Model Tax Convention

Indeed, by considering these concepts in the international juridical context, it should be borne in mind that Italy is a member country of the Organisation for Economic Co-operation and Development (OECD), and has also signed the OECD Model Tax Convention on Income and on Capital, whose main purposes is to clarify and standardize the fiscal duties of taxpayers that carry out activities in other countries, in order to avoid cases of double taxation.

Article 5 of the Convention concerns the definition of permanent establishment.

Paragraph 3 of Article 5, referring to the specific case of a construction site, states that «a building site or construction or installation project constitutes a permanent establishment only if it lasts more than twelve months», thus elevating the time duration provided by Italian Law.

International practice: OECD MTC Commentary

The Commentary on Article 5 specifies also that the term «building site or construction or installation project» must be referred not only to the construction of buildings but also to the ones of roads, bridges or canals, the renovation of buildings, roads, bridges or canals, and to the laying of pipelines and excavating and dredging. Also, the specific term «installation project» refers not only to an installation project related to a construction project but includes also the installation of a complex machine in an existing building or outdoors. It is also specified that other related activities, such as on-site planning and supervision of erection of buildings are covered by Paragraph 3.                    

Additionally, it is stated that the so called “twelve months test” applies to each individual site or project, and more specifically each building site should be regarded as a single unit, «even if it is based on several contracts, provided that it forms a coherent whole commercially and geographically». Moreover, it is immaterial for a building site to be considered as a permanent establishment the lack of a fixed place, since the very nature of these kind of projects is that the activities may need to be relocated continuously, as the single project evolves. Also, according to the Commentary, whenever «parts of a substantial structure are assembled at various locations within a country and moved to another location for final assembly», this is considered part of a single project and so it would constitute a permanent establishment if it exceeded the twelve months limit.

Furthermore, in the specific case in which an enterprise (general contractor) subcontracts different parts of a single project to other enterprises (subcontractors), the period spent by each subcontractor has to be considered as time spent by the general contractor on the project, thus creating a permanent establishment if this period of time lasts more than twelve months (cf. Tax Ruling No. 277/E, 3rd July 2008).

Bilateral Conventions and thresholds for a construction site PE

None of the various conventions stipulated between Italy and other countries provides a specific paragraph regarding construction sites or installation projects. Indeed, they are included in the positive list of cases that can be considered permanent establishment. In order to determine the ab initio period of twelve months, the OECD Commentary states that a site exists from the date on which the contractor starts to work, including any preparatory activity, and it is considered to exist until the work is completed or permanently abandoned. However, seasonal or temporary interruptions are considered as included in determining the duration of the worksite (e.g. due to bad weather, shortage of materials or labour difficulties).

For a building site or construction or installation project to be considered as a permanent establishment in Italy, its duration shall exceed the threshold set by each Convention agreed by the residence country of the specific trade business with the Italian State. Duration may vary between 6, 9 and 12 months, with some exceptions that can be found in the table below.

*or where such temporary chain or activity, following the sale of machinery or equipment, lasts less than 6  months and the expenses incurred for the purpose of such chain or activity exceed 10% of the sales price of the machinery or equipment.

** or where a building site or construction, installation or assembly project or supervisory activities in connection therewith, being incidental to the sale of machinery or equipment, continues for a period not exceeding six months and the charges payable for the project or supervisory activity exceed 10 per cent of the sale price of the machinery and equipment.

Mutual Agreement Procedures (MAP)

Whenever a taxpayer of a Contracting State laments a case of double taxation not in accordance with the provisions of the Convention, the dispute can be solved through the mutual agreement procedure as well as the arbitration – with that not affecting the taxpayers’ right to the ordinary legal remedies available.

In multiple bilateral conventions signed between Italy and other Contracting States it is stated, reflecting Article 25 of the OECD Convention, that to eliminate double taxation and resolving conflicts regarding the interpretation of provisions, the Contracting Parts shall establish a mutual agreement procedure. These procedures are widely described in Circular No. 21/E, 5th June 2012 of the Italian Revenue Agency.

The mutual agreement procedure can be initiated by a taxpayer without having to wait until the taxation considered not in accordance with the Convention has been notified. According to the Commentary, it is sufficient that the actions of one or both Contracting States will result in such taxation, and it appears as a risk not merely possible but probable.

For the procedure to be set in motion, the case must be presented to the competent authority of the Contracting State of which the taxpayer is a resident, and according to Paragraph 1 of Article 25, within three years from the first notification of the action resulting in taxation not in accordance with the Convention (even if most bilateral conventions concluded by Italy identified a shorter deadline, generally two years from the first notification).

If the objection is founded and justified but the case cannot be solved by the competent authority itself, Paragraph 2 states that it “shall endeavor” to resolve the case by mutual agreement with the authority of the other Contracting State, meaning that they are obliged to negotiate to seek a solution in a fair and objective manner, in accordance with the terms of the Convention and the general principles of international law – it should be noted, however, that according to the Commentary authorities have no obligation to achieve a result.

The same procedure must apply in cases of doubts or difficulties arising from interpretation or application of the Convention (Paragraph 3).

In summary, there are two main phases:

1. the first one is the setting in motion of the procedure itself by the taxpayer, and it concerns the negotiations between the taxpayer himself and the competent authority of his resident State.
2. The second one occurs when the competent authority of the first phase cannot reach an agreement with the taxpayer and addresses the competent authority of the other Contracting State to consult together. According to the Commentary, both the competent authorities are obliged to start negotiations, but not to solve the case.

The next Paragraph 5 (added in 2008) states that whenever, under Paragraph 1, a person has presented a case and the competent authorities, within two years from it, are unable to reach an agreement, any unresolved issue arising from the case shall be submitted to arbitration «if the person so requests in writing». This other mechanism can be used only if the decision on the same issues has not been rendered by a court or administrative tribunal of one of the States and if there is a specific provision in the bilateral convention.

However, according to the Commentary to Article 25, this process is «an integral part of the mutual agreement procedure and does not constitute an alternative route to solving disputes concerning the application of the Convention».

Moreover, the new mandatory procedure of arbitration is applicable subject to its inclusion in new (or existing) bilateral conventions being negotiated (or renegotiated). With such a clause, the efficiency of MAP is reinforced.