Permanent Establishment: widening the net

05 December 2014

Permanent establishment (PE) is a key concept in determining which country can tax the profits of a business established in one country and operating from another. It is defined in the majority of double taxation treaties as, broadly, a fixed place through which the business is wholly or partly carried on.

An enterprise trading in a treaty state through a PE will generally be subject to tax in that state on any profit that is attributable to its PE. If its activities do not amount to a PE, they may escape the tax net.

How can Permanent Establishment be avoided?

The most common ways to avoid PE status are:

Commissionaire Arrangements

A business established in a low tax jurisdiction could appoint a local agent with authority to conclude contracts in its name, with the intention that only the agent's commission should be taxed locally and the remaining profit is taxed offshore. However, in these circumstances the Organisation for Economic Co-operation and Development (OECD) Model Tax Convention (Articles 5(5) and 5(6)) deems the offshore entity to have a PE in the customers' territory. Businesses often use commissionaire and similar arrangements to avoid this form of deemed PE status.

Specific Activity Exemption

Certain activities, listed in the exceptions in Article 5(4) of the OECD model, are specifically prevented from leading to deemed PE status. These include: using facilities solely for display; delivery or storage of goods; maintaining a place of business solely for purchasing goods; and maintaining a place of business solely to carry on preparatory or auxiliary activities, such as gathering information.

Splitting Contracts

A deemed PE will not arise if contracts are entered into for a period of less than 12 months (Article 5(3)). It is therefore common for contracts to be artificially split. Short term contracts, of less than 12 months each, are allocated to different companies.

What could be changing?

Last month (November 2014), the OECD published a discussion paper outlining the options for amending the definition of permanent establishment to address the three main strategies employed in avoiding PE status. This follows the OECD's 15-point action plan on Base Erosion and Profit Shifting (BEPS), published in July 2013. The proposals are:

Commissionaire Arrangements:

There are four separate proposals. Each aims to ensure that where any intermediary operates in a contracting state with the intention that contracts will be concluded for performance by a foreign enterprise, the foreign enterprise should be treated as having a PE in that contracting state. The only exception to this approach is where the intermediary carries out its activities as an independent business.

Specific Activity Exemption:

The OECD is considering a wide range of proposals, including:

  • Making all the exemptions subject to a 'preparatory' or 'auxiliary' condition; or
  • Removing the word 'delivery' so that storage warehousing is no longer automatically exempt; or
  • Removing the reference to 'purchasing' so that such activities are no longer automatically exempt.

Splitting Contracts:

An automatic aggregation rule is proposed so that activities carried out by an enterprise and one or more associates of that enterprise at a particular site or premises will be together to establish whether the 12-month threshold has been met.

A note for Insurers

The discussion paper also highlights a growing concern about artificial avoidance of the PE threshold in the insurance sector, for example where a large network of exclusive agents sell insurance in a country on behalf of a non-resident insurer.

The OECD proposes to deem an insurer to have a PE in a state if it collects premiums within that states or insures risks there via an intermediary who is not an independent agent. Alternatively, the OECD may simply rely on the general changes for concluding contracts described above.

What's next?

The proposals are neither conclusive nor inevitable. They do not necessarily represent the consensus views of the OECD. They do appear workable and may well form the basis of any proposed change to the international tax landscape. If the proposals are adopted, many multinational groups will need to review their international operations, including their corporate structures and cross-border contracting arrangements.

Have your say

Parties interested in voicing their opinions must provide comments to Marlies de Ruiters via email at taxtreaties@oecd.org by 9 January 2015.

Any comments made will be publicly available and any persons or organisations making such comments should also indicate whether they wish to speak in support of their comments at a public consultation meeting scheduled to be held in Paris at the OECD conference on 21 January 2015.

For further information, please contact our Tax team.


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