On 15 May 2015 the OECD published a new discussion draft on action 7 of the action plan on base erosion and profit shifting (BEPS). Action 7 is concerned with changing the definition of a permanent establishment (PE) in the model treaty to prevent artificial avoidance of PE status, including the use of commissionaire arrangements or the use of the PE exemptions for specific activities. Profit attribution issues are also to be addressed and some aspects arising from tax challenges of the digital economy also need to be taken into account, for example to ensure that core activities cannot benefit inappropriately from the exception from PE status and artificial arrangements for sales of goods or services cannot be used to avoid PE status.
The first discussion draft on action 7 was released on 31 October 2014 and this set out a number of PE avoidance strategies and alternative options on how to deal with those strategies. The new discussion draft reflects comments received on that previous draft and the discussions at the public consultation meeting held on 21 January 2015. The intention was to move from the series of options first published and the new draft puts forward one preferred proposal for dealing with each PE avoidance strategy.
Comments on the discussion draft are invited by 12 June 2015. The comments will be published by the OECD but there will not be a consultation meeting on this draft.
Commissionaire arrangements
In a commissionaire arrangement products are sold by an entity in its own name but on behalf of the foreign enterprise that owns the products. The foreign enterprise is therefore able to sell products in the country without having a PE there. As the commissionaire does not own the products it sells it cannot be taxed on them and is only taxed on the remuneration for its services.
Generally if an intermediary is performing activities that will result in the conclusion of contracts to be performed by a foreign enterprise that foreign enterprise is considered to have a sufficient nexus in the country for tax purposes, unless the intermediary performs the activities as part of an independent business.
The discussion draft proposes dealing with the issue by a revised paragraph 5 to Article V. Where a person is acting on behalf of the enterprise and habitually concludes contracts; or negotiates the material elements of contracts that are in the name of the enterprise or 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 for the provision of services by the enterprise, the enterprise will have a PE in respect of those activities.
The revised paragraph 6 of Article V will change the provision in respect of independent agents. Where a person acts exclusively or almost exclusively on behalf of one or more enterprises to which it is connected that person is not to be considered an independent agent. A person is connected to an enterprise if one possesses at least 50% of the beneficial interests or shares in the other or if another person possesses a 50% interest in both. A person is considered to be connected to an enterprise if based on the relevant facts and circumstances one has control of the other or both are under the control of the same person.
The commentary to Article V will be amended to clarify that a person is acting on behalf of an enterprise in a State when the person involves the enterprise to a particular extent in business activities there. Examples include an agent acting for a principal, a partner acting for a partnership or a director acting for a company.
The phrase “concludes contracts” includes situations where a contract is legally concluded by a person. This does not necessarily need active negotiation of the terms but could include where a contract is concluded by a person accepting on behalf of an enterprise an offer made by a third party to conclude a standard contract with the enterprise.
A contract may be concluded in a State even where the contract is signed outside that State. For example in a situation where the conclusion of the contract results from the acceptance by a person acting on behalf of an enterprise of an offer to enter into a contract made by a third party it is not relevant that the contract is signed outside the State.
The commentary clarifies that the phrase “concludes contracts or negotiates the material element of contracts” should be interpreted to cover cases where the activities that a person exercises in a State are intended to result in the regular conclusion of contracts to be performed by a foreign enterprise. Paragraph 5 could be used where a person who is part of the sales force makes or accepts contractual offers, even if standard contracts are used, for example where the person solicits or receives contractual offers that are sent directly to a warehouse from which goods belonging to the enterprise are delivered and transactions are routinely approved.
The commentary would also clarify that the reference to contracts in the name of the enterprise could apply to certain situations where the name of the enterprise is undisclosed in the contract.
Specific activity exemptions
The preferred solution to the problem of inappropriate use of specific activity exemptions is to amend the commentary to apply a “preparatory or auxiliary” condition to all the activities listed as exempt, so these would not exclude the possibility of a permanent establishment if they are performed as core activities. This corresponds to Option E listed in the original discussion draft.
As some of the commentators considered that the expression “preparatory or auxiliary” was not precise enough the discussion draft includes more guidance in the Commentary as to the meaning of that phrase.
Fragmentation of activities
Another method of avoiding a permanent establishment has been to fragment activities among related parties. This will be done by introducing a rule applying to situations where related enterprises are performing activities none of which constitutes a permanent establishment but the combination of the activities at the same place or at different places goes beyond the level of preparatory or auxiliary activities.
Splitting contracts
The possibility of taxpayers splitting contracts to avoid restrictions imposed by paragraph 3 of Article 5 of the Model Treaty is to be dealt with by the addition of an example of the Principle Purposes Test (PPT) in the commentary to the Model. As an alternative provision a more automatic rule would be included in the commentary for situations where a country was unable to address the issue through domestic anti-abuse rules and would not include the PPT in a treaty.
Insurance
No specific rule for insurance enterprises is to be added to Article 5 of the OECD Model. Instead of this BEPS concerns where a large network of exclusive agents is used to sell insurance for a foreign insurer are dealt with by the general changes that will apply to all taxpayers.
Attribution of profits to PEs
More work will be done on clarifying the attribution of profits to PEs arising as a result of the issues raised in the discussion draft. This work cannot be done until the work on action 7 or actions 8 to 10 (transfer pricing) has been completed. The follow-up work on profit attribution will therefore be done after September 2015 and the necessary guidance will be provided by the end of 2016 which is the deadline for negotiation of the multilateral instrument implementing the results of work on action 7 of BEPS.