On 22 March 2018 the OECD issued a report entitled “Additional Guidance on the Attribution of Profits to Permanent Establishments, BEPS Action 7”. This latest guidance follows the issue of a discussion draft on 22 June 2017 containing guidance on attribution of profits to permanent establishments (PEs) and replacing a previous draft published in July 2016.

The guidance issued by the OECD’s Inclusive Framework on BEPS is part of the follow-up work after the issue of final reports of the project on base erosion and profit shifting (BEPS). Action 7 of the BEPS action plan was concerned with preventing the artificial avoidance of PE status. The final report on action 7 stated that the changes made to the definition of a PE in Article 5 of the OECD Model did not require substantive changes to the rules and guidance on the attribution of profits to PEs under Article 7.

However the report noted that there would be a need for additional guidance on the application of the attribution rules in Article 7 to the PEs that would result from the changes to the definition of a PE recommended in the BEPS final report.  The further work would also need to take account of the recommended changes made elsewhere in the BEPS final reports on transfer pricing, such as the work related to intangibles, risk and capital.

The additional guidance now issued in the OECD report looks at Article 5 (5) of the OECD Model and includes examples of a commissionaire structure for the sale of goods; an online advertising sales structure; and a procurement structure. Additional guidance is included on PEs created as a result of changes made to Article 5 (4) and there is an example on the attribution of profits to PEs arising from the anti-fragmentation rule in Article 5 (4.1.

Changes to Article 5 (4) of the OECD Model

The BEPS report on action 7 recommended changes to be made to the exceptions in Article 5 (4) that activities previously considered to be merely preparatory or auxiliary could now correspond to core business activities, depending on the circumstances.  Article 5 (4) has been amended to ensure that each of the exceptions is limited to activities of a preparatory or auxiliary nature.

Concerns arising from the application of Article 5 (4) also involve the possibility of fragmentation of activities to avoid PE status by splitting up a cohesive business and creating a number of small operations that do not in themselves form a PE as they benefit from exceptions in Article 5 (4). The report on BEPS action 7 therefore proposed an anti-fragmentation rule.

The anti-fragmentation rule is in paragraph 4 (1) of Article 5 of the OECD Model. It provides that there is no exception in the case of activities that might be viewed in isolation as preparatory or auxiliary but are part of a larger set of business activities in the source country where the combined activities constitute complementary functions that are part of a cohesive business operation.

The additional guidance issued by the Inclusive Framework now includes an example involving the activities of warehousing, delivery, merchandising and information collection activities to illustrate the application of Article 5 (4) of the OECD Model.

Changes to Article 5 (5) and 5 (6) of the OECD Model

The additional guidance also covers PEs arising from the operation of Article 5 (5) and 5 (6) of the OECD Model. The final BEPS report on Action 7 noted that where the activities of an intermediary in a country are intended to result in the regular conclusion of contracts to be performed by a foreign enterprise, the foreign enterprise should be seen as having a sufficient nexus in the country unless the intermediary is performing its functions in the course of an independent business.

The final BEPS report required the definition of a PE in Article 5 and the commentary to be amended to specifically deal with commissionaire arrangements and other similar arrangements.

The BEPS recommendations included amendment of Article 5 (5) of the OECD Model to provide that an enterprise has a PE in a state if a person acts in that state on behalf of the foreign enterprise and in doing so 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.

Included in the additional guidance now issued by the Inclusive Framework are examples involving a commissionaire structure; the sale of advertising on a website; and the procurement of goods.