KPMG report: BEPS Action 7 (artificial avoidance of PE status)

BEPS Action 7 (artificial avoidance of PE status)

The Organisation for Economic Co-operation and Development (OECD) on May 15, 2015, released a revised discussion draft pursuant to Action 7 (preventing the artificial avoidance of PE* status) under the base erosion and profit shifting (BEPS) project.

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*PE=permanent establishment


The OECD has requested that comments be sent by June 12, 2015. No public consultation is planned for this revised discussion draft.

Read the revised discussion draft [PDF 315 KB] under BEPS Action 7.

The following KPMG report provides initial impressions and observations about the revised discussion draft.


Action 7 of the BEPS Action Plan calls for the development of:


…changes to the definition of PE to prevent the avoidance of PE status in relation to BEPS through the use of commissionaire arrangements and the specific activity exemptions.


The revised discussion draft describes proposals for amending Article 5 of the OECD Model Treaty chosen from the 14 options described in the original discussion draft. These proposals relate to four specific concerns with current Article 5:

  • The artificial avoidance of PE status through commissionaire arrangements and similar strategies
  • The artificial avoidance of PE status through the specific activity exemptions for preparatory and auxiliary activities
  • The splitting-up of contracts to circumvent the time restrictions imposed under paragraph 3 of Article 5, relating to building, construction, and installation projects
  • The application of the dependent agent rules to insurance contracts

KPMG observation

The revised discussion draft states that although it includes specific proposals, it does not yet represent a consensus. Nonetheless, the revised draft does seem to reduce significantly the range of issues still under discussion. Like the original discussion draft, the revised discussion draft does not contain any specific rules applicable to electronic commerce.

The revised discussion draft also notes that any amendments to the definition of a PE in Article 5 must consider how the amendments would interact with the attribution of profits to a PE under Article 7 of the OECD Model Treaty. However, such work would need to take into account the results and proposals of the BEPS action dealing with transfer pricing—in particular the work regarding transfer pricing issues related to intangibles, risk, and capital. Accordingly, the follow-up work on attribution of profits issues related to Action 7 will be carried on after September 2015, with necessary guidance to be issued before the end of 2016. 

Commissionaires and similar strategies

Under existing paragraph 5 of Article 5, the activities of a person may create a permanent establishment (PE) for an enterprise only if the person “habitually exercises, in a Contracting State an authority to conclude contracts in the name of the enterprise.” BEPS Action 7 addresses two aspects of this provision.

  • The first is whether and how the requirement that the contracts “be in the name of the enterprise” would be expanded.
  • The second is whether the requirement that the person “conclude contracts” would be expanded to include activities that ultimately result in the conclusion of contracts by the nonresident enterprise.
According to the discussion draft, commissionaire and similar arrangements have been employed to exploit paragraph 5 of Article 5. A commissionaire acts as an undisclosed agent. Because a commissionaire contracts with customers in its own name (and not in the name of the enterprise for which it is acting), a commissionaire may not be considered to be acting “in the name of the enterprise,” even though the commissionaire receives only a limited commission and any residual profits accrue to the enterprise the commissionaire represents.
Similarly, an enterprise may use a disclosed agent that operates for a limited service fee to solicit and negotiate contracts on its behalf, and take the position that it does not have a PE because the enterprise executes all contracts outside the host country. In this case, the agent is not considered to exercise an authority to conclude contracts on behalf of the enterprise.
The revised discussion draft adopts Option B from the original discussion draft. Under this proposal, paragraph 5 would be amended to read as follows: 
5. Notwithstanding the provisions of paragraphs 1 and 2 but subject to the provisions of paragraph 6, where a person is acting in a Contracting State on behalf of an enterprise and, in doing so, habitually concludes contracts, or negotiates the material elements of contracts, that are 
a) in the name of the enterprise, or  
b) for the transfer of the ownership of, or for the granting of the right to use, property owned by that enterprise or that the enterprise has the right to use, or 
c) for the provision of services by that enterprise,
that enterprise shall be deemed to have a permanent establishment in that State in respect of any activities which that person undertakes for the enterprise, unless the activities of such person are limited to those mentioned in paragraph 4 which, if exercised through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph.
The revised discussion draft addresses the first issue regarding current paragraph 5 by retaining the current standard that the contract must be “in the name of” the nonresident enterprise, unless the contract is for (1) the transfer of the ownership of property, (2) the granting of the right to use property, or (3) the provision of services by the nonresident enterprise. The revised Commentary would make clear that the revised language is not intended to cover limited-risk distributor arrangements.
The revised discussion draft then addresses the second issue with current paragraph 5 by providing that a person may create a PE for a nonresident enterprise when it negotiates “the material elements of a contract” on behalf of the nonresident enterprise, as well as when it formally concludes contracts. Proposed changes to the Commentary would make clear that the “material elements” of a contract are those that are the key ingredients of the agreement. Thus, these would “typically include the determination of the parties between which the contract will be concluded as well as the price, nature and quantity of the goods or services to which the contract applies.”

KPMG observation

The proposal adopted in the revised discussion draft is the narrower of the two alternatives suggested in the original discussion draft. As further explained in the commentary, this suggested change appears to be only a clarification, or at most a modest expansion, of the existing language of paragraph 5.

Paragraph 6 of Article 5 contains an exception to paragraph 5 under which a nonresident enterprise is not considered to have a PE in a Contracting State merely because it carries on business in that State through a broker, general commission agent, or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business.

The revised discussion draft would provide that an agent will never qualify for the independent agent exception if it operates exclusively or almost exclusively on behalf of one or more “connected” enterprises. For these purposes, whether two companies are “connected” generally would be determined under a 50% vote-and- value test; however, a Contracting State could also treat two persons as connected if, based on the facts and circumstances, one controls the other or both are under the control of the same persons or enterprises. Also, the accompanying Commentary suggests that an agent that concludes less than 10% of its sales for unrelated persons should be considered to be acting “exclusively or almost exclusively” for connected enterprises.

KPMG observation

The revised discussion draft contains a narrower revision to the independent agent exception than the option contained in the original discussion draft in two respects. First, it permits an agent that acts on behalf of a single unrelated party to qualify as independent. Second, the concept of “connected” persons is narrower than the concept of “associated enterprises” contained in the original discussion draft.

The “specific activity” exemptions

Paragraph 4 of Article 5 of the OECD Model Treaty contains exemptions from PE status for preparatory and auxiliary activities. Subparagraphs 4(a) through (d) list specific activities that do not create a PE, while subparagraph 4(e) provides an exemption for any other activities that are of a preparatory or auxiliary nature.

The revised discussion draft proposes adopting Option E from the original discussion draft, which requires that each of the specific activities stated in existing subparagraphs 4(a) through (d) be preparatory and auxiliary in nature in order for the activity to not create a PE. Since existing subparagraphs 4(e) and (f) already provide for an exemption for any activity or combination of activities to the extent they are “of a preparatory and auxiliary character,” the new requirement that each specific activity or the overall activity must be preparatory and auxiliary would have the practical effect of eliminating the exemptions that are now provided for in subparagraphs 4(a) through (d).

KPMG observation

This proposal will serve to add a facts-and-circumstances-based standard to the existing PE safe harbors. Such a proposal will inject a great deal of uncertainty to PE determinations and may lead to significantly more assertions of PEs and associated disputes. For example, paragraph 22 of the proposed commentary would provide for the possible existence of a PE when a taxpayer maintains a large warehouse with a significant number of employees.

The revised discussion draft also proposes adding an expansive anti-fragmentation rule as new paragraph 4.1 of Article 5. Under the proposal, the activities of two connected enterprises occurring at the same or different places could be aggregated to determine if such activities go beyond the preparatory or auxiliary standard— even if neither of the connected enterprises maintains a fixed place of business that constitutes a PE, provided the activities carried on by the two enterprises constitute complementary functions that are part of a cohesive business enterprise. Similarly, the activities of a single enterprise at two or more locations could be combined to create a PE. This proposal is the same as Option J of the original discussion draft, except that it uses the concept of “connected” enterprises, rather than the broader concept of “associated” enterprises

KPMG observation

  • Proposed paragraph 4.1 (as drafted) refers to the activities of two enterprises, not “two or more” enterprises. It thus implies that fragmentation of activities among three or more nonresident enterprises may successfully avoid a PE, as long as no two enterprises together exceed the preparatory and auxiliary threshold.
  • The anti-fragmentation rule may have the effect of a “force of attraction” rule when a nonresident enterprise related to a resident operating company of a Contracting State engages in limited activities within that State, as the combination of the two enterprises’ activities will exceed the preparatory and auxiliary threshold and may constitute complementary functions that are part of a cohesive business enterprise.

Splitting up contracts

The splitting of contracts among related entities in order to avoid the PE threshold is a concern for building, construction, and installation projects. It also is a concern in the case of treaties that contain a “service PE” provision. The revised discussion draft proposes adding an example to the Commentary on the principal purpose test proposed as part of Action 6. This example would demonstrate a factual situation when a 22-month construction project is broken into two separate contracts between two separate but related entities, each lasting 11 months for a principal purpose of which was to obtain the benefit of paragraph 3 of Article 5. The Commentary concludes that such an arrangement would be contrary to the object and purpose of the rule.

For Contracting States that do not include a principal purpose test in their treaties, the revised discussion draft recommends including an automatic rule dealing with the splitting of contracts among connected enterprises within the Commentary to Article 5 as stated in Option K of the original discussion draft.


The revised discussion draft proposes that no specific rule for insurance enterprises is to be added to Article 5 (Option N of the original discussion draft). Hence, whether an insurance enterprise’s use of agents in a State creates a PE would be determined under the general rules of paragraphs 5 and 6.

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