On Friday 31 October, the OECD published their latest Base Erosion and Profit Shifting (“BEPS”) discussion draft. This latest report deals with Action 7 (“artificial avoidance of permanent establishment (“PE”) status”) and proposes 13 “Options” (some are alternatives) to change the definition of PE in the OECD Model Tax Treaty. The draft does not propose changes to the Commentary on the Model Treaty and, as such, the changes would apply from the earlier of a renegotiated treaty, or the proposed Multilateral Instrument (pursuant to BEPS Action 15) coming into force. However, the changes are very far-reaching and would significantly extend the meaning of PE, as well as rendering that meaning less precise and therefore increasing the scope for conflicting tax claims.
The following is a brief overview of some of the changes being proposed:
Commissionaire arrangements and similar structures
The discussion draft outlines four Options for changes to Article 5(5) (“dependent agent”). Options A and B would replace the “concluding contracts in the name of the enterprise” test with a much broader test by reference to whether the activities of the agent result in the conclusion of contracts in the name of the enterprise, or for the transfer of property owned by the enterprise, or for the provision of services by the enterprise. The discussion draft, in line with earlier BEPS pronouncements, explicitly targets commissionaire structures.
Specific activity exemptions (Article 5(4))
The draft envisages major changes to these. Specifically, Option F would remove the word “delivery” from Article 5(4)(a) and (b), resulting in a warehouse that stores goods for delivery to customers being potentially a PE. This appears originally to have been focused on electronic trading, but could bring into the tax charge a wide range of hub structures implemented by companies to streamline the supply chain. Options G and H would remove the exemption for purchasing activities, so that a purchasing office would in future also potentially be a PE. Alternatively, Option E would keep the exemptions unchanged but would impose a requirement that the activities be of a preparatory or auxiliary character; this requirement would introduce a strong risk of tax authorities arguing that the storage of goods for delivery or the purchasing activities are a core part of the business and cannot therefore be auxiliary or preparatory.
Options K and L are intended to prevent avoidance of PE status through fragmentation of contracts. Specifically, Option K would mean that, in determining whether an enterprise has a “construction or installation” fixed place of business, one looks at activities carried out not only by the enterprise but also by related parties. Where a contract is performed partly by a local subsidiary, the presence of the local subsidiary at the customer’s premises would be aggregated with that of the foreign enterprise in determining whether the duration test (12 months in the OECD Model) is satisfied. This would mean that a lot of contracting work, which currently does not give rise to a PE, would do so in future.
Download the full report.
See more general background on the BEPS project.