BEPS Action 7 has been principally focused on preventing avoidance strategies that circumvent the current Permanent Establishment (PE) definition and, in particular, commissionaire arrangements.
Changes are also proposed to counteract perceived abuses of the specific exceptions to PE status by fragmenting a cohesive operating business into several small operations. This may arise as a result of conducting different operations through separate legal entities or, for example, in property development, by organising the construction activity to be carried on by different entities successively to avoid a permanent establishment being triggered due to the elapse of time carrying on the building work.
The report concludes that "as a matter of policy, where the activities that an intermediary exercises in a country are intended to result in the regular conclusion of contracts to be performed by that foreign enterprise, that enterprise should be considered to have a sufficient taxable nexus in that country unless the intermediary is performing these activities in the course of an independent business".
Dependent agent PE
The principal change proposed to combat commissionaire arrangements (which rely on the non-resident enterprise not being legally bound by the person acting as commissionaire) is that Action 7 proposes amending Article 5(5) of the OECD Model Tax Convention to define a dependent agent PE to arise 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. Such contracts may either be in the name of the enterprise, or for the transfer of ownership or use of property to which the enterprise is entitled, or for the provision of services by the enterprise. It is this latter expansion of the contracts which fall within the scope of Article 5(5) which expressly counteracts commissionaire arrangements.
There is limited guidance on the circumstances in which a person habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise. The guidance seeks to draw a distinction between situations where a person solicits and receives orders and those in which the activity is limited to promotion and marketing.
In practice, there will be many circumstances where the position is less clear. In both the private and listed funds contexts, it is common to appoint an investment adviser on an advisory basis. The expansion of the definition of permanent establishment to include situations where the investment adviser habitually plays the principal role leading to the making of investments without material modification by the offshore fund will require these arrangements to be reviewed. If the investment adviser does negotiate the material elements of such contracts, it may be difficult for it to rely on the advisory nature of its activity to avoid being treated as a dependent agent PE.
In equipment leasing transactions, the lessor may use a marketeer in a particular jurisdiction to negotiate the terms of a lease with a lessee, but a team based in the lessor's jurisdiction often makes the principal decisions in relation to the leasing contracts. In these situations, the construction of the terms "principal role" and "without material modification" will be fundamental to the analysis. The proposed guidance is of limited assistance in construing these terms.
The revised Article 5(6) contains a carve out for independent agents acting in the ordinary course of their business but introduces an important qualification to this - an agent will not be considered independent if it acts on an exclusive or "almost exclusive" basis for an enterprise with which it is "closely related".
A person will be considered to be closely related to an enterprise if one possesses directly or indirectly more than 50 per cent of the beneficial interest (or, in the case of a company, the voting rights or the equity interests) in the other, or if another person holds equivalent rights in both the person and the enterprise.
Avoidance through specific exemptions
The existing Article 5(4) deems certain facilities maintained by an entity which are used for storage, display, delivery, processing by third parties or buying goods, etc, not to give rise to a permanent establishment. The rationale for this is that such activities are preparatory or auxiliary to an entity's main business, but this has not historically been a specific requirement for all of the exclusions.
Action 7 proposes amending all the exclusions in Article 5(4) of the OECD model treaty to ensure that each exemption is subject to a general override that the overall activity of the fixed place of business must be of a preparatory or auxiliary character.
However, Action 7 recognises that some jurisdictions will seek to combat any abuse of these provisions by an anti-fragmentation rule and may choose this as an alternative approach. The effect of this rule would be to determine whether a fixed place of business PE exists having regard to the overall activity conducted by any closely related entities (whether in a single location or multiple locations) in that jurisdiction, if they constitute complementary functions as part of a cohesive business operation.
Similarly, Action 7 recommends that contract splitting is tackled either through the introduction of the principal purpose test (recommended in Action 6) or by a more specific rule being introduced.
Next steps
The changes to the OECD Treaty and commentary are intended to be adopted as part of the multilateral instrument which is intended to be negotiated by the end of 2016. This workstream is ongoing but we would expect the changes to the definition of dependent agent PE to be included in this instrument.
It will, however, be interesting to see the approach taken by individual states in relation to the proposed amendments to the specific exemptions where states have been given different options from which to choose.
In a similar time-frame, the OECD are working on changes in their guidance on the attribution of profits to PEs which is expected to be published before the end of 2016. The quantification of profits to the PE arising as a result of Action 7 is not straightforward and it is hoped that this additional guidance will provide clarity on some of these issues.
Please click on the links below for the other articles in the November 2015 tax newsletter:
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