New administrative practice and higher permanent establishment risk for machinery and plant engineering firms in 2026

The concept of permanent establishment for construction or installation projects

For machinery and plant engineering companies, the permanent establishment (PE) for construction and installation projects is in practice the most important kind of PE. Project-related supply, installation and commissioning services abroad are typical aspects of what is undertaken and often involve long periods working at the site. If and when this brings about a taxable presence or nexus is primarily based on national law and secondarily (or in the case of cross-border matters) according to the applicable double taxation agreement (DTA).

a) PE for construction and installation projects under German law (section 12 sentence 2 no. 8 of the Fiscal Code)

Under German law, carrying out construction or installation establishes a PE if the activity takes longer than six months (section 12 sentence 2 no. 8 of the Fiscal Code [Abgabenordnung]). Unlike the “general” PE under section 12 sentence 1 of the Code, which requires a fixed place of business or facilities, no such local establishment is required for this. Rather, the actual performance of the construction or installation project over the period is sufficient. In this way, the German legislature has created another type of PE that is linked only to the duration of the project and applies regardless of whether the enterprise has its own facilities available onsite or not.

In calculating the duration, all activities are to be taken into account that are attributed by nature to the construction or installation project. It is the total duration of the project that is decisive, not individual phases or the time individual workers are deployed. This also includes the activities of subcontractors if their activity is economically and organisationally attributable to the construction or installation project. Brief interruptions do not affect the measurement of the period.

b) Building site or construction or installation project PEs under Art. 5(3) of the OECD Model Tax Convention

Article 5(3) of the OECD Model Tax Convention lays down a minimum period of more than 12 months. A building site or construction or installation project PE only comes about once this threshold is exceeded. The OECD interprets the concept broadly: it includes not only standard construction services but also installation, assembly and infrastructure projects and larger renovation and modernisation measures. The installation of complex technical plants, including ancillary work abroad, is often very important to machinery and plant engineering firms.

The project begins when actual construction or installation work starts or the building site is set up. Preliminary activities such as initial inspections or brief advance meetings do not trigger the start of the period. Rather, the period starts as soon as preliminary activities become part of the actual set-up of the building site, e.g. by setting up containers, equipment stores or working areas.

Periods of time spent by subcontractors are to be attributed to the general contractor if they can practically access the building site during these times. This is particularly determined by overall responsibility for the project, the actual possibility of accessing the place where the activity is carried out, and the organisational management of the work. The construction or installation project PE continues to exist until completion or until the project is finally abandoned. Test and trial phases also typically count towards the duration of the project. The period is not paused for temporary breaks due to weather, material shortages, seasonal breaks etc.

Attribution of the project is particularly crucial. Several contracts may be assessed as being a single project if they are economically or geographically related. To avoid the splitting up of contracts, the OECD expressly recommends aggregating the deployment times of closely related enterprises if the activities build on each other in terms of content or would otherwise be bundled in a single contract if it were not for tax reasons.

c) Distinction from other types of PE

Not all activities carried out by a machinery and plant engineering company onsite count as a construction or installation project PE. In German practice, pure planning, monitoring or consulting services, and subsequent services, maintenance or repairs are not included in Art. 5(3). Such activities may, however, establish a PE under Art. 5(1) if a fixed place of business exists. This distinction is becoming more important in practice and is explained below.

Divergences between the German and OECD understanding and OECD Commentaries on Art. 5(3) of the OECD Model Tax Convention (updated 2025)

Although Art. 5(3) lays down a highly harmonised international framework for building site or construction or installation project PEs, in practice there continue to be divergences from the German understanding for machinery and plant engineering. While the OECD Model Tax Convention only assumes the existence of a construction or installation project PE when a duration threshold of 12 months has been exceeded, German tax law starts from a project duration of over six months (section 12 sentence 2 no. 8 of the Fiscal Code). This means that PE risks can begin much earlier from the German perspective than they can under treaty law.

Furthermore, Germany takes a more restrictive approach to a qualitative interpretation of the concept of PE in certain situations than the OECD Commentary does. This is particularly evident in short, entirely practical activities which do not involve any fixed on-site organisation. A commonly cited example is that of painters and decorators. While the OECD Commentary considers a painter’s working for an extended period of time at the customer as potentially establishing a PE, Germany rejects this generalisation. The German practice is that a painter usually does not establish a PE if they are not given any authorisation over facilities and the work is completely integrated into the commissioning party’s processes.

This view can be applied to many typical cases in machinery and plant engineering. In particular, Germany usually does not typically classify purely practical activities (e.g. assembly or servicing) as a construction or installation project PE, even when they occur repeatedly, or as a “general” PE under Art. 5(1), if the duration thresholds are not exceeded and an independent fixed place of business is not established. In these cases, this activity as such is usually not sufficient to assume the existence of a PE.

The OECD Commentary on Art. 5(3) from 2025 mostly confirms the legal position already in existence since the BEPS update of 2017. The twelve-month threshold was not modified, nor were sector-specific particularities introduced for machinery and plant engineering. From a practical point of view, it is therefore more of a confirmation of the status quo and not an actual tightening or expansion of the definition of construction or installation project PEs.

Practical effects

1. Planning projects early to avoid unintended PEs

For machinery and plant engineering firms, the rules described clarify why it is necessary to monitor project-related deployment times early and continuously. The different duration thresholds under national law and treaty law make is necessary to clearly distinguish between determining a PE under German law and under DTA standards. Thorough time and duration threshold management is therefore a central instrument in managing tax risks, particularly for longer activities abroad.

This requires planning staff deployments abroad ahead of time, both in terms of offers and contracts, so as not to unintentionally exceed thresholds, or at least to be able to identify them early. Ideally, the duration thresholds should already be considered in the marketing and contracting process, and deployment and resource planning should be closely coordinated with the marketing and tax departments. Getting tax advice early enables projects to be structured appropriately and PE risks to be managed properly ahead of time.

During the entire project, particular attention should also be paid to supplementary or downstream activities beyond standard construction and installation. Even planning, monitoring, service, maintenance or repairs of short duration can lead to the establishment of a PE under Art.5(1) if there is a fixed place of business on site.

The Federal Fiscal Court “locker” case (judgement of 7 Jun 2023, I R 47/20) shows that even for negligible service or installation work, even the smallest exclusively-used areas at the customer’s site can be enough to establish a PE. Particularly when fitters or service technicians are deployed abroad for longer periods, this aspect can take on considerable practical significance. The Federal Fiscal Court “taxi” case (judgement of 18 Dec 2024, I R 47/21) also follows this understanding, according to which a desk in a shared office can already be deemed a fixed place of business if it is mostly available to the taxpayer to carry on their business activities.

2. Tax duties and profit attribution after a PE has been established

In light of this, it is essential to record project and deployment times in full in order to separate the organisation of on-site activities clearly and to manage subcontractor services closely, since their working times can be attributed to the general contractor. Establishing a PE abroad usually brings far-reaching tax duties with it, including registration, payroll and withholding tax liabilities, local declaration requirements and potential VAT consequences.

If it is only later determined that a foreign PE has been established and the income made in the state in which the work was performed is taxed there, adjustments usually need to be made to German corporate income tax or trade tax returns, such as by applying the allowance or crediting method under the relevant DTA. There are often also payroll tax consequences for the workers concerned, who should adjust their personal income tax assessments and contact their local tax offices accordingly. This typically requires obtaining confirmations from their employers concerning the payroll tax that is liable or paid abroad.

It often goes unnoticed in practice that tax evaluation does not end when a foreign PE is assessed. Another step is to calculate the profit attributed to the PE. The German view is to determine this using the arm’s length principle based on the Authorised OECD Approach (AOA), as specifically laid down by the Administrative Principles for the Attribution of Profits to Permanent Establishments.

Machinery and plant engineering firms should in particular note that German tax law contains special rules for construction or installation project PEs. These typically recognise cost-based payments (e.g. cost-plus pricing) as being at arm’s length when they carry on purely practical activities without any real entrepreneurial risk. In contrast to this, “general” PEs under Art. 5(1) may require significantly deeper function and risk analysis with a differing attribution of profits to match.

Determining the type of PE is therefore not only crucial to whether a tax presence has been established but also for the subsequent attribution of profits between the headquarters and the PE. Profit should be clearly attributed according to transfer pricing principles. There are also stand-alone documentation requirements relating to the foreign PE unrelated to this that should be taken into account early.

Conclusion

The draft new Federal Ministry of Finance Circular makes clear that building site or construction or installation project PEs continue to pose a key area of tax risk to machinery and plant engineering firms. PE risks arise not only from standard construction and installation work but increasingly also from ancillary and subsequent activities and from organisational details onsite.

It is therefore crucial to manage deployment times, staff deployment and the scope of work early and throughout the project. If a PE is established, it must be ensured that profit is attributed according to transfer pricing principles, tax requirements are met and the PE documentation requirements are fulfilled.