The law of unintended consequences

Law of unintended consequences

James Macky expounds on potential unintended consequences of the OECD's proposed changes to the definition of a Permanent Establishment.

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The scales of justice

The Concise Encyclopaedia of Economics explains the law of unintended consequences as the actions of people, and especially of government, always having effects that are unanticipated or unintended.

For example, in 1958 the Chinese Communist Party carried out the Great Sparrow Campaign, with the aim to rid China of seed thieving sparrows and thereby increase rice yields. After forcing the sparrows to near extinction, China suffered from a crop failure due to plagues of locusts and other insects. The insects thrived because their natural predators had been removed. An unintended and devastating consequence.

It is my sense that the changes to the treaty definition of Permanent Establishment (PE) proposed by the Organisation for Economic Co-operation and Development (OECD) in Base Erosion Profit Shifting (BEPS) Action 7 will also have unintended consequences, namely the proliferation of PEs resulting from procurement operations.

The definition of PE is being changed so a taxpayer will have a PE in a country where another entity habitually plays a principal role leading to the conclusion of contracts in the name of the taxpayer. This change will, as intended, capture Commissionaire arrangements and marketing activities carried out for the taxpayer or by the taxpayer in a foreign country and create a tax liability there.

As procurement operations for multi-national enterprises also habitually negotiate contracts that are concluded by other taxpayers, procurement operations can also meet the criteria within the proposed PE article. This potential outcome was not discussed in the Action 7 Final Report.

After the implementation of the new PE definition – if this happens – I would expect that every Australian subsidiary of a multinational enterprise that engages with its group’s procurement hub, most commonly in Singapore, will need to consider if it has a new PE. Not quite a PE plague, but certainly an unintended consequence.

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