A permanent establishment is the place where economic activity is carried out and income is generated. The location of the permanent establishment determines where and how much tax is payable.
The definition and criteria for establishing a permanent establishment are set out in the double taxation agreements (DTAs) between Germany and Bulgaria and in the Corporate income tax Act (CITA). It should be noted here that, as an international treaty, a DTA takes precedence over local law. In the event of a conflict between the two laws, the DTA takes precedence over the CITA.
Permanent establishment within the meaning of the double taxation agreement (DTA)
The definition of the term "permanent establishment" is essential for the application of the DTA. This term is defined in Art. 5 (1) DTA and states that it refers to the physical place of business through which a company carries out all or part of its business activities. This does not refer to the subject matter of the activity that the person carries out, but to the specific work that they perform in return for remuneration. Auxiliary and preparatory activities are therefore excluded, unless they are directly related and become the person's main activity. The idea behind the creation of a permanent establishment is that it represents a permanent presence in the foreign person's country and a permanent source of income from business activities in that country. The duration also depends heavily on the length of time, which is usually six months. The duration for construction and assembly work is usually 12 months.
In all DTAs to which Bulgaria has acceded, it is assumed that profits at any place of business are taxed in accordance with the relevant domestic legislation. This means that there are no DTAs that exempt profits from the permanent establishment from tax. In the absence of a place of establishment, all income from a commercial activity is taxed in the state where the recipient is resident and is exempt from withholding tax (Art. 7(1) DTA). For example, if the circumstances for applying the DTA preference in connection with the remuneration owed to a foreign legal entity are proven, the foreign person concerned (income recipient) must declare that there is no permanent establishment in Bulgaria to which the said income is connected.
In short, if a person earns income from a permanent establishment, the income is taxed in accordance with the relevant domestic legislation. In cases where it is necessary to prove that the income was not earned through a permanent establishment (i.e. the income is not taxable outside the country of habitual taxation), the person must refer to the above criteria.
The DTA contains provisions for various types of income – dividends, interest, royalties and licence fees, technical services, etc. For specific types of income and tax, the agreements between the participating states must be examined on a case-by-case basis. Each piece of legislation contains different provisions on the order of application of the DTA.
Permanent establishment within the meaning and for the purposes of the Bulgarian Corporate Income Tax Act
According to Art. 3 (2) of the Corporate Income Tax Act, domestic legal entities are taxable on their profits and income from all sources in Bulgaria and abroad. A permanent establishment in a country leads to taxation of the net result (profit) of the business activity at that location in the country concerned. If there is no taxable profit, there is no taxation.
Section 1(2) of the Supplementary Provisions of the Corporate Income Tax Act states that "permanent establishment" means a permanent establishment within the meaning of Section 1(5) of the Supplementary Provisions of the Tax and Insurance Procedural Code. This means:
- A specific location (owned, rented or otherwise used) where a foreign person carries out all or part of their business activities in the country. This can be, for example: Administrative headquarters, branch office, commercial agency registered in the country, office, law firm, studio, factory, workshop, shop, warehouse, assembly facility, construction site, mine, quarry, borehole, oil or gas well, spring or other facility for the extraction of natural resources;
- the exercise of activities in the country by persons authorised to conclude contracts on behalf of foreigners. An exception is the activity of independent agents under Chapter Six of the Commerce Code;
- Permanent performance of commercial transactions with the place of performance in the country, even if there is no permanent representative or specific location.
It should be noted here that the provision in question does not apply if there is a double taxation agreement (DTA) with the country concerned and the prevention of tax evasion through income tax (Art. 5(4) of the Constitution of the Republic of Bulgaria).
The Corporate Income Tax Act expressly specifies income with a source indication in which country no permanent establishment arises. This means that this income is taxable in Bulgaria (Corporate Income Tax Act "Profits and income from sources in Bulgaria", Art. 12 (2)-(5) and (7)-(9)).
Art. 12, para. 7 of the CITA states that income from agriculture, forestry, hunting and fishing in the territory of Bulgaria originates from a source in the country, even if no permanent establishment has been established. This income is linked to the use of natural resources on Bulgarian territory, so it is logical that it should be considered as income originating in Bulgaria and taxed there. None of the double taxation agreements to which Bulgaria is a party contain any exemptions or preferential arrangements allowing lower tax rates.
The income referred to in Art. 12, paras. 2-5 and 8-9 of the Corporate Income Tax Act is subject to withholding tax at the time of its calculation. Such income includes, for example, income from the ownership of capital, property, intellectual or industrial property, remuneration for the management and control of a Bulgarian legal entity, remuneration for technical services and others. For these types of income, the gross income is taxed without taking into account the amount of profit generated or whether there is any profit at all. The only exception is income arising from the sale or replacement of real estate and financial assets. In this case, the net income is taxed, i.e. the taxable profit generated, and only if there is any (as in the case of the permanent establishment type of tax). Persons subject to withholding tax (10%) have the option of submitting a recalculation of their annual tax return (CITA, Art. 202a) for income due during the year. In this way, under certain conditions, the excess tax paid at source is refunded to foreign persons.
Income that is not listed as income with Bulgaria as the source (CITA, Art. 12, paras. 2-5 and paras. 7-9) is not taxed in the country and is paid in full to the foreign person.
Art. 12 para. 10 CITA states that the place of payment of income is not taken into account when determining the source of income. It therefore depends on whether the person receives income from the sources listed in Art. 12 CITA, and not on where this income is paid.