BEPS discussion draft: preventing the artificial avoidance of PE status
In the OECD BEPS Action 7 draft report, fundamental changes are introduced to the permanent establishment (PE) rules. I will discuss the following structures that the OECD proposes to challenge:
- Structures that has been set up as a commissionaire arrangements
- Structures that make use of the auxiliary PE exemption status
- Structures to split up contracts to avoid the construction PE status
Many MNC’s have set up commissionaire structures in the past in order to shift profit from local sales and distribution companies to a principal company in a more favorable tax jurisdiction. These local operations were often initially set up as ‘buy-sell’ company. Many multinationals changed the risk profile of these buys-sell operations by introducing a commissionaire structure, consequently reducing the remuneration of the local operations in favor of the principal. The “additional profit” of the principal party is in most situations not subject to tax in the country of the sales operation as a result of the wording of the PE article in the relevant bilateral tax treaty. This may be different in cases where the local sales and distribution company was changed into a regular agent. Nevertheless, implementing a commissionaire structure was a risky tax planning strategy since many tax authorities have challenged this and the outcome of the several court cases in different countries shows different outcomes (inter alia Zimmer – France, Roche – Spain)
The OECD is now proposing to introduce new language that will try to abolish the distinction between the agent and commissionaire model in the OECD tax treaty model regarding the tax treatment of the principal. The OECD has provided 4 alternative formulations, which in essence creates a local PE of the principal if the local sales company is not performing its activities in the course of an independent business (and is an affiliated entity).
The proposed formulations will introduce more subjectivity into the determination of whether a PE exist and seems to impact a wide range of arrangements (inter alia the Limited Risk Distributor). If a PE is recognized, the next question will be what profit needs to be allocated to this PE. This is a matter of applying the transfer pricing rules which is in many countries are derived from previous work of the OECD on this matter.
Auxiliary PE exemption
The current wording of the OECD bilateral tax model treaty leaves room for interpretation whether business activities can benefit from the PE exemption of article 5 paragraph 4.
The OECD provides various options to counter abuse of the PE exemptions, including:
- All options mentioned in article 5 paragraph 4 should be subject to a preparatory or auxiliary condition
- Removing the term ‘delivery’ from subparagraphs a) and b), which prevents that for instance warehouses of Amazon cannot benefit from the PE exemption provided in these paragraphs
- Deleting the exception for ‘purchasing’ in paragraph d) which will restrict the possibility of (large) purchase and procurement companies of multinational companies to apply the PE exemption
- Counter the fragmentation of business activities by setting up separate legal entities in order to benefit from the PE exemption of subparagraph f. Splitting up the ‘value chain’ (inter alia purchase, storage, delivery etc.) and allocating these ‘auxiliary activities’ to separate affiliated legal entities will according to the proposed formulation no longer work.
Split up contracts
In many tax treaties, construction and installation projects that last more than twelve months will result in a local PE. In order to avoid this PE status, taxpayers divided contracts up into several parts, each covering a period less than 12 months and attributed this work to several legal entities of the same international group.
The OECD proposes two alternatives to counter these structures:
- Introducing an rule that also takes into account activities of affiliated companies at the same building site or construction project for the measurement of the twelve months’ period
- Relying on the General Anti Abuse Provision as has been proposed in action 6 of the OECD BEPS project
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