Commercial Reason and the Permanent Establishment Test: Recalibrating Article 5 in the OECD 2025 Commentary

The author is Vishal Sharma, 3^rd year student at Chanakya National Law University, Patna

Introduction

One of the most basic principles in international tax law, the permanent establishment (PE), is under strain amid the surge in hybrid and remote work options. For years, the test under Article 5 of the OECD Model Tax Convention was based on the notion of a "place of business" that is fixed and distinct. This model was tested during the COVID-19 pandemic as employees started working remotely in workplaces across the country, and it has already proved to be challenging: employees can now carry out all aspects of their employer's business from outside the state where the employer has its traditional offices. Whether such an arrangement creates a PE has caused considerable confusion and uncertainty in both practice and doctrine.

 The 2025 Update adds new paragraphs 44.1- 44.21 to the Commentary on Article 5 that prescribe a more fact-sensitive approach focusing on the principle of “commercial reason.” This article explores the concept, its meaning, its structural role, its boundaries and its policy implications in general. It also responds to a question that has been ignored by institutional actors much of the time: whether and how this framework has a ‘purchase’ in the jurisdictions, most obviously India, where it has been expressly rejected. 

The focus of this Article is the “commercial reason” as a carve-out from the scope of Article 5, a mechanism that excludes from the scope of PE those cross-border and remote-work arrangements that would otherwise satisfy the formal requirements of the fixed-place PE test but in which the connection to the source state lacks a real business reason. Viewed this way, rather than as a new analytical criterion for the definition of when a PE exists, this understanding will have implications on the approach taken by the Indian practitioner to the 2025 Update; namely, as a diagnostic tool to understand the direction of travel of OECD-aligned jurisdictions and to enable India's jurisprudence to be compared with this trend.

The Traditional PE Framework

As defined in paragraph 1, Article 5 of the Agreement, a PE of an enterprise shall consist of a fixed place of business where the business of the enterprise is conducted in whole or in part. The Commentary to the IFRS has introduced four cumulative requirements which have been confirmed by domestic case law in each OECD member states: (i) the presence of a place of business (broadly defined to encompass any premises, facility or installation); (ii) quality of fixedness (the presence of a geographical link to a particular place and an adequate level of permanency); (iii) the place being at the disposal of the enterprise; and (iv) the business of the enterprise being carried on through the place. 

Article 5 also distinguishes between the fixed-plate PE in paragraph 1 and the dependent agent PE in paragraph 5, which occurs when a person habitually exercises an authority to enter into contracts in the name of the enterprise in the source state. The exception to this is made for persons acting as independent agents (paragraph 6). A safe harbour of preparatory or auxiliary activities is provided in paragraph 4.

 The 2025 Commentary is not added to or supplementary to this existing structure, but rather exists within it. What the OECD has put forward is not a new addition to the treaty but an additional interpretation for applying the treaty to a type of fact-pattern for which the pre-existing Commentary was not that good, the cross-border home-office situation. Commercial reason in the right sense does not inquire into the existence of a place of business. It queries whether situations normally considered to be places of business should not be denied PE status because the enterprise did not have a “genuine commercial interest” in the individual's presence in the source state. This separation between the existence of a PE and a carve-out from PE exposure is the conceptually central point between the 2025 framework and much of the early commentary on the Update. 

The OECD 2025 Shift: Carve-Out, Not Criterion

The Commentary on Article 5 (Home Offices and similar locations) has been significantly amended in the 2025 Update. The paragraphs 18 and 19 of the Commentary, which were devoted briefly and only partially to the concept of home offices, are deleted in their entirety and replaced by a separate section of the Commentary, from paragraph 44.1 to paragraph 44.21.

The new framework is a progressive one. It explains why the formal requirements for fixedness and disposal are met by a home used continuously for work, but which has no real connection between the enterprise and the place from which it was taken, and notes that this is typically under the control of the individual, rather than the enterprise, giving the Commentary a filter.

Secondly, the 50 per cent working-time indicator is added to the 2025 Commentary. In general, a home or other location would not be regarded as being a place of business of the enterprise if the person worked less than 50 per cent of his or her total working time for the enterprise at that location during any 12 months. This is not a safe harbour; the use of the word ‘generally’ is intentional. What it does is create a presumptive definition of exclusion for the vast majority of hybrid workers, who work across several locations but primarily from a foreign home, from which they will receive full PE analysis.

Third, and most important, when the 50 per cent mark is passed, then “commercial reason” is the primary filtering criterion. At this stage, the test is not to ascertain the existence of a fixed place of business at the time of the crossing of the threshold and ongoing use of the place; The formal requirements of paragraph 1 could easily be met. Instead, it is important to consider whether the link between the enterprise and the source state is of a commercial nature that is substantial enough to trigger PE implications. In paragraph 44.19, there is a carve-out for situations where there is no commercial reason: “that place would not be a place of business of the enterprise unless other facts and circumstances indicated otherwise.” 

In its default state, commercial consideration is absent; therefore, the default is exclusion. This is a major shift of focus. The elder Commentary asked: "Has the enterprise made this house its office? The new Commentary asks the question: Does the enterprise have a commercial basis for being represented in this jurisdiction, of which the home is the manifestation? The second question is a bit trickier, and it's the appropriate one in a world where many employers prefer to do business virtually rather than in person. The 2025 Update extends the BEPS Action 7 Final Report's emphasis on substance over form to the particular context of remote work.

The Meaning of “Commercial Reason”: Facilitation, Not Convenience

The word commercial reason is not to be understood as a technical term. The term commercial reason is not a technical term, but a facilitative term.

A commercial reason will be deemed to exist “where the physical presence of the person in that State will itself facilitate the carrying on of the business of the enterprise, for example, where persons or resources are in that State to which the enterprise needs to have access for the purposes of carrying on its business activities”. The concept is facilitated by physical presence: The enterprise must obtain a business advantage from the presence of that person in the source state, which can only be attributed to their physical presence in the source state and not to the work that they do.

This is furthered by a counterfactual, analytically precise, in paragraph 44.12, which is that a commercial reason will exist in place, but not on the premises. This counterfactual is a link between the commercial reason and the classical “at the disposal” question. It is not a question of whether the employee uses his home for work, but whether the enterprise has a valid need for business premises in the source state, which is fulfilled by the home. If there is such a functional need, the home shall be, in substance, the enterprise's office in the source state; the PE exposure shall follow.

The Commentary lists several categories of activity that generally create a commercial reason: regular client meetings which are facilitated by physical proximity; developing a customer base or identifying business opportunities; supplier relationships where there is a need for physical interaction; real-time engagement of customers across time zones (as illustrated in Example Eat paragraph 44.21); access to research personnel or specialist expertise; and the provision of a service that requires physical presence at the customer's premises. The Commentary states these categories with confidence, but it is markedly less forthcoming on how an enterprise is meant to prove that any one of them actually applies to its own arrangement.

Three circumstances are expressly excluded from constituting a commercial reason. Remote working for the purpose of filling a vacancy or holding on to an employee is not enough (paragraph 44.15). Home working is not a commercial motive to reduce office expenditure; it is a motive to reduce expenditure, so the source state's commercial interest does not come into play (paragraph 44.16). Just because a customer, supplier or counterparty is in the source state does not mean that it requires the person to be physically present to facilitate business engagement (paragraph 44.18).

These exclusions go beyond being merely illustrative; they mark the outer boundary of the carve-out's rationale. An enterprise that offers an employee the option of working from home for any of these reasons has not thereby established a business presence in the source state it has simply accommodated a preference. What the Commentary does not supply, however, is any indication of how a taxpayer or a revenue authority is meant to prove which side of that boundary a given arrangement falls on. The categories and the exclusions are both stated as conclusions; the reasoning that would let either party test them against a contested set of facts is left for practice to invent.

Limits, Ambiguities, and the Problem of Divergence

The commercial reason concept carries at least three layers of interpretive difficulty for practitioners to navigate: a threshold question, an evidentiary void the Commentary never fills, and a jurisdictional divide over whether the concept applies at all. The first is the threshold issue. The presumption for 50 per cent of the working time is a broad presumption, rather than a bright line. This does not imply that any modest level of time spent by a founder, partner or senior executive at a foreign home would automatically draw the attention of the PE community; Israel has expressly stated that it will reserve the right to determine the significance of seniority vis-à-vis the working-time metric. In reality, this "gap" allows for administrative overreach by the source states that have an interest in claiming PE exposure. 

The second is definitional openness. Commercial reason is not defined in a closed manner; the factors and examples from the Commentary do not constitute a test that can be mechanically applied. There is a high risk of divergent domestic interpretation, but no theoretical risk. India's reservation is quite specific: it says it “does not agree with the conditions, including time threshold and commercial reason, detailed in paragraphs 44.1 to 44.21;” and that an individual's home could be interpreted as being at the disposal of the enterprise without resorting to a commercial reason analysis. It requires engagement, not footnoting, to this reservation. The OECD Commentary does not seek to impose obligations on the parties to the Convention, but rather serves as a persuasive aid in interpreting the Convention. 

This definitional openness has a sharper, more structural dimension than a simple gap in illustrative examples. The Commentary states the circumstances that will generally establish a commercial reason, but nowhere specifies how an enterprise is meant to demonstrate that any of them exist in a given case, nor what a revenue authority is meant to accept as proof that they do not. Elsewhere in its own material, the OECD does not leave a subjective business judgment unsupervised in this way: the Transfer Pricing Guidelines require a Master File and Local File precisely because a standard resting on commercial rationale needs contemporaneous documentation before it can be administered consistently. Commercial reason, arguably the most consequential subjective judgment now built into Article 5, is asked to function without any comparable evidentiary architecture.

A second and related difficulty is temporal rather than evidentiary. The Commentary treats commercial reason as a fact that either exists or does not, offering no guidance on when it should first be tested or how it should be reassessed as an arrangement evolves. Take an employee who relocates to a foreign state for personal reasons, at a time when the enterprise has no clients or operations there; eighteen months later, the enterprise begins serving clients in that state and assigns the work to the employee already living there. A commercial reason has now plainly emerged, yet the Commentary does not indicate the date from which it should run the date of assignment, the date of the first client meeting, or the date of an internal strategy decision despite that date determining years of attributable profit, registration obligations and interest exposure. The OECD’s own practice elsewhere, from annual transfer-pricing documentation to the periodic recalculations required under the Pillar Two GloBE rules, treats dynamic factual questions as requiring periodic reassessment rather than a one-off determination. Commercial reason, as currently drafted, receives no such treatment.

The Commentary carries significant interpretive weight in jurisdictions that accept it, and none in those that expressly do not  but the position for India is not a simple binary. India's tax treaties, such as those with the United Kingdom, Germany, France and the United States, predate the 2025 Update and have been negotiated in the context of a previous Commentary. The Indian courts and the Indian Income Tax Appellate Tribunal (ITAT) in their interpretation of Article 5 in those treaties should decide which vintage of Commentary is relevant and the extent of weight that should be given to the OECD Commentary that India has expressly disavowed. In Engineering Analysis Centre of Excellence v. CIT (2021), the Indian Supreme Court applied the OECD Commentary as an aid to interpretation without concluding, while, and more generally, the ITAT considered it as an aid to interpretation, but one that Indian policy reservations were taken into account. 

This means that the commercial reason carve-out, which OECD-aligned jurisdictions will afford to insulate genuine convenience-based remote work from PE exposure, may not be available in India. An Indian resident of a foreign enterprise, who works from his Indian home, may have to face the CBDT's scrutiny in India on the older “at the disposal” analysis, which would create PE liability in India, that the jurisdiction of the enterprise would not recognise. This means that a treaty imbalance occurs in practice. If a foreign enterprise's Indian residential employee works from home, India may argue that it has PE in India according to its PE definition, while the residence state argues that it does not have PE in India according to the 2025 Commentary.

 The resulting double taxation risk is clearly within the ambit of MAP under Indian treaties, which has been a slow and uncertain process in the past. The 2025 Update is not an irrelevance to Indian practitioners advising foreign enterprises that have Indian remote workers; rather, it is a risk indicator and not a safe harbour. The third challenge is that of the uneven adoption of treaties. The applicability of PE exposure will depend on the facts of the arrangement, the interpretation of that arrangement by the states and the treaty itself. 

The 2025 Update is not binding to any treaty currently in effect, but addresses future treaty negotiations and interpretation of current treaties where both parties agree to the Commentary's relevance. That implies the framework will use an uneven approach within the global treaty network for years to come, and practitioners will have to tailor their approach to each client's potential treaty exposure. 

A Procedural Answer: Toward a Structured Commercial Reason Test

The interpretive difficulties identified above point toward a specific remedy, not merely a further caveat. What the 2025 Commentary needs is not a redefinition of commercial reason but a sequence of procedural questions capable of turning the concept from an intuition into an administrable test. Four such inquiries would do most of the work. The first is whether a genuine business rationale exists for the individual’s presence, assessed at the time the arrangement or the relevant duties were assigned, and by reference to the enterprise’s clients, suppliers and operational footprint rather than to employee preference. Where that rationale is plainly absent, the carve-out should apply without more; where it is present or plausible, the remaining inquiries determine whether it is sufficiently evidenced and sufficiently current to carry PE consequences.

The second inquiry is what documentation substantiates the claimed rationale. An evidentiary hierarchy, similar in spirit to what the Transfer Pricing Guidelines already require of comparable subjective judgments, would treat contemporaneous material market-entry plans, client contracts requiring local presence, internal strategy documents as primary evidence, and would confine reconstructed, after-the-fact testimony to a secondary and less persuasive role. The third is when the rationale arose and when it should be tested again: assessed at inception and reassessed whenever the individual’s functions, client base or the enterprise’s strategy in that state change materially, in the same way the OECD already requires periodic reassessment under transfer-pricing documentation and the Pillar Two GloBE rules.

The fourth and final inquiry is what follows once the first three are answered. If a commercial reason is established, evidenced and has persisted for a period sufficient to satisfy the permanency requirement, the home becomes a place of business; if not, the carve-out applies. Framed this way, the burden of proof also resolves itself in a principled manner: the enterprise carries the initial burden of demonstrating commercial reason through primary documentation, and the revenue authority carries the burden of showing that the documentation does not reflect the substance of the arrangement. None of this requires new treaty text. It requires the OECD to do for commercial reason what it has already done for transfer pricing and Pillar Two pair a substantive standard with the procedural detail needed to apply it consistently.

Policy Implications: The Incomplete Globalisation of PE Doctrine

The Incomplete Globalisation of PE Doctrine, Policy Implications From a policy angle, the 2025 Commentary takes a deliberate step to balance between two symmetrical dangers, one to over-tax mobile workers and globally distributed enterprises under the PE doctrine by misclassifying trivial remote-work situations as PEs, and the other to under-tax enterprises by excluding from the PE doctrine a site where the formal definition of a fixed place of business is not met, but a business home is. The 50 per cent threshold and the commercial reason carve-out complement each other and cover both risks, but in the OECD context only. Externally, the balance is set differently, and in India, it might be set to systematically favour taxation in the source state. This is no coincidence. India's reservation to paragraphs 44.1-44.21 is a well-thought-out policy position that the PE status of a state in which an individual works for a foreign enterprise should not be denied because the foreign enterprise did not have any business interest in that state.

Read only as a matter of policy preference, India’s rejection is easy to dismiss as protective self-interest. Read against the procedural gaps identified above, it looks more like a diagnostic: India has not rejected the idea that commercial necessity should bear on PE analysis, but rather a standard for which the OECD has supplied no evidentiary or temporal method of application, and which a tax administration could not apply consistently even if it wished to. This makes sense from an economic sovereignty point of view. India earns a lot of value from its citizens' work; giving away PE status to foreign enterprises by claiming that they have come to India for business because the personal choice of the employees is commercial is a way for the Indian Revenue to lose out on the Indian tax base. The general takeaway is that, in OECD-aligned jurisdictions, PE doctrine is increasingly moving towards an economic basis, while it has remained formally anchored in India and other non-OECD economies. It is not a unified global regime for taxing remote work; it is a set of competing regimes operating in parallel, generating disputes as a matter of design rather than accident. The mutual agreement process is the process outlined; however, it is not meant to deal with the variety of cases that will be generated from the widespread use of hybrid working. A more lasting fix would come from India agreeing with the OECD or a bilateral discussion of specific exceptions to India's treaties for remote working, which is not in sight. The divergence this produces is not abstract: an employee who spends most of the year working from a home in a source state and visits a client there only once a quarter would fall outside PE exposure under the OECD’s own worked examples, while the same facts would likely sustain a PE assertion under India’s unmodified “at the disposal” standard.

Conclusion

One of the most important interpretative advances that have occurred in the OECD 2025 Commentary on Article 5 is the concept of "commercial reason. In its structural sense, it is not meant to be a fresh test of whether PE exists but to carve out from the exposure, remote work situations in which the enterprise's linkage to the source state is commercially empty. 

This shift from formal presence to business need is exactly what is needed at a time when a framework is required to face a world of truly mobile labour. The implications for practitioners in OECD-compliant jurisdictions are straightforward, provided that the commercial reason is considered: document the commercial justification for cross-border remote work arrangements; carefully review and establish whether the commercial reason is met; determine whether there is an actual engagement with the client, supplier or operation in the source state that creates a tie. If those elements are not present, the 2025 Commentary offers a defensible reason for not exposing PE. Whether that defence is easy or hard to mount in practice will depend on whether the OECD eventually supplies the procedural detail this article has argued is missing. For Indians, it is more complicated. India has turned down the commercial reason framework. This implies that the carve-out to shield foreigners from exposure to PE in their jurisdictions, which is regularly available in OECD-aligned jurisdictions, is unavailable in India without further proof. The CBDT's assertions under the previous, more general rule for Indian employees of overseas companies continue to apply to people working from home in the country. 

The 2025 Update does not address the Indian PE risk issues faced by foreign enterprises that have Indian remote workers and should not be taken as such. What they should take for granted is that for the next decade, Indian ITAT and High Court cases will be fought on this basis; the pressure on India to clarify its domestic legislation, either in circulars issued by CBDT or through the renegotiation of treaties, or through judicial elaboration, will grow in proportion to the increasing amount of cross-border remote work. The deeper question that the 2025 Update poses for Indian tax policy is this: In a world where the OECD has made enterprise intent the key determinant in PE analysis, can India continue with an approach that is based on physical presence as the key determinant without resulting in systematic over-taxation of foreign investment received into the country? 

It won't just be a matter of doctrinal preference, but will also be influenced by the larger economic advantage that India can derive from different companies coming into the country and hiring Indians. The cost of doctrinal divergence will one day outpace the benefits of the commercial reason framework, or its near equivalent, as incorporated into OECD practice, and it will enter Indian practice. In this respect, the 2025 Update is a framework that is worth watching even if it doesn't necessarily require implementation. Whether commercial reason becomes a durable and workable addition to PE doctrine, or a well-intentioned reform that generates more uncertainty than it resolves, will depend less on the concept itself than on whether the OECD is willing to give it the same procedural scaffolding that every comparable standard in its own practice already has.