On 22 June 2017 the OECD issued a new discussion draft with guidance on attribution of profits to permanent establishments (PEs), to replace the previous draft published in July 2016. The new discussion draft outlines the general principles for the attribution of profits to PEs in the circumstances addressed by the final BEPS Report on Action 7 and includes illustrative examples. Comments on the draft guidance are requested by 15 September 2017.
The final BEPS report recommended that where the activities of an intermediary in a country are intended to result in regular conclusion of contracts to be performed by a foreign enterprise then the foreign enterprise has a sufficient nexus in that country, unless the intermediary is performing its activities in the course of an independent business. The report recommended a change to the wording of Article 5 (5) of the OECD Model to ensure that a PE is created where a person habitually concludes contracts or habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise, and where the contracts are either in the name of the enterprise or are for the transfer of goods or services by the enterprise,
A change to Article 5 (6) was also recommended in the final BEPS report to the effect that, although a PE would not be deemed to exist if the person acting for the foreign enterprise is doing so in the ordinary course of its business as an independent agent, a person will not be considered to be an independent agent if it acts exclusively or almost exclusively on behalf of one or more enterprises to which it is closely related.
The changes to Articles 5 (5) and 5 (6) of the OECD Model concern the definition of a PE rather than the attribution of profits which is determined under Article 7. The threshold for creating a PE has been modified but the nature of the deemed PE has not been modified. The approach to the attribution of profits to a PE does not therefore need to be changed. The rights and activities from contracts to which Article 5 (5) refers will be allocated to the PE but Article 7 also requires that activities performed by the rest of the enterprise to which the PE belongs or by other enterprises must be properly remunerated. Profits of the PE under Article 7 will be those it would have derived if it were a separate and independent enterprise performing the activities that the dependent agent performs for the foreign enterprise. These profits will include the arm’s length reward for its services to the foreign enterprise.
Where the intermediary and the foreign enterprise are associated enterprises profit adjustments under Article 9 are permitted when the conditions of the transactions are not consistent with the arm’s length principle. The order in which Article 7 and 9 are applied should not affect the amount of profits over which the source country has taxing rights. The approach applied by a jurisdiction should be applied consistently and could be made public to provide taxpayers with certainty. The discussion draft notes that the country’s taxing rights are not necessarily exhausted by ensuring an arm’s length compensation to the intermediary.
There should also be no double taxation of profits on both the intermediary and foreign enterprise, for example from allocation of risk under Articles 7 and 9. Legal and administrative systems should prevent double taxation. Some countries simplify the task by collecting tax only from the intermediary even though the tax is calculated by reference to the activities of both the intermediary and the PE of the foreign entity created under Article 5 (5). As the potential burden on the foreign enterprise of complying with host country tax and reporting requirements for a PE could be large, the guidance does not prevent the continuation of this simplified administrative procedure,
The discussion draft contains example in relation to a commissionaire structure; the sale of advertising on a website through a related intermediary; and the procurement of goods through a related intermediary. There is also an example relating to the anti-fragmentation rules and the changes to Article 5 (4) under which activities previously considered to be preparatory or auxiliary are now excluded from the exception in Article 5 (4) where they correspond to core business activities.