On 5 October 2015, the OECD published its final report on Action Point 7 of the BEPS initiative (Preventing the Artificial Avoidance of Permanent Establishment Status), which entails a significant change to the current definition of permanent establishment (PE) in article 5 of the OECD Model Tax Convention. The purpose of the redefined definition is to prevent the use of certain strategies to circumvent the PE status, resulting in a shift of profits from the place of sale to a foreign jurisdiction. The changes will be reflected directly in the updated version of the OECD Model Tax Convention.
According to the final report on BEPS Action Point 7, two of the most commonly used arrangements to prevent the creation of a PE are (i) facilitating commissionaire arrangements and thus circumventing the "dependent agent rule", or (ii) applying the exemption relating to "preparatory and auxiliary" activities included in article 5(4) of the OECD Model Tax convention (2014).
Thus, BEPS Action Point 7 contains two main amendments which directly address those two arrangements:
- Amendments to article 5(5) regarding the "dependent agent rule"
- Amendments to article 5(4) concerning the "preparatory and auxiliary" exemption
Amendments to the "dependent agent rule"
Subject to the current definition of a PE in article 5(5) of the OECD Model Tax Convention, an enterprise will be treated as having a PE in a state if a person, under certain conditions, is acting on behalf of that enterprise in that particular state. Article 5(5) of the OECD Model Tax Convention determines that only persons having the authority to conclude contracts may lead to a permanent establishment for the enterprise. Such persons are considered "dependent agents". They may be either individuals or companies, and they need not be residents of or have a place of business in the state in which they act on behalf of the enterprise.
Because article 5(5) of the OECD Model Tax convention relies on the formal conclusion of a contract in the name of the foreign enterprise, some enterprises have utilised commissionairearrangements to bypass the formal requirement. In a commissionaire arrangement, the contract itself is formally considered as concluded by the person acting as a commissionaireand is therefore not considered binding on the foreign enterprise. As such, the use ofcommissionaire arrangements enables the enterprise to sell its goods in a foreign state without having to create a PE in that particular state.
In Action Point 7 of the BEPS report, the scope of the PE definition is extended to include situations where the contracts are entered into by a person who "habitually concludes contracts, or habitually plays the principal role leading to the conclusion of contracts".
Such activity will constitute a PE of the foreign enterprise, provided "that [the contracts] are routinely concluded without material modification by the enterprise". According to the amended commentary to the redefined article 5(5), the quoted phrase is aimed specifically at situations where the conclusion of the contract is a direct result of the activity performed in a state by that person acting on behalf of the foreign enterprise.
Furthermore, the situations in which a person may be considered an "independent agent" (i.e. s(he) does not constitute a PE) have been narrowed down. As such, a person will not be considered an independent agent if the person acts exclusively or almost exclusively for one or more enterprises to which the agent is "closely related". Subject to the redefined article 5(5), a person will be considered "closely related" to an enterprise if the person or the enterprise possesses, directly or indirectly, more than 50% of the beneficial interest in the other party.
Amendments to the "preparatory and auxiliary" exemption
Article 5(4) of the OECD Model Tax Convention (2014) contains a list of specific activity exceptions, according to which a PE may be deemed not to have been created. Generally, Activities of a preparatory or auxiliary nature (for example the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise) are not deemed to include the creation of a PE.
The final report on BEPS Action Point 7 contains an amendment to the actual definition of article 5(4) but, more importantly, it also introduces the new article 5(4)(1).
The new article 5(4)(1) provides that the activities of related parties must be viewed as a whole, rather than on an enterprise-by-enterprise basis, when determining whether the "preparatory and auxiliary" exception is applicable.
Consequently, an enterprise will have a difficult time arguing that the work carried out in a state falls within the "preparatory and auxiliary" exemption, if that same enterprise – or a closely related enterprise – has a PE in the state in question.
The amendments to article 5 of the OECD Model Tax Convention contained in the OECD Final Report on Action Point 7 will undoubtedly enhance the scope of situations in which the activities of an enterprise will constitute a PE.
It will therefore be necessary to conduct a thorough review of the activities performed by an enterprise in a foreign state in order to prevent unintended tax consequences stemming from the new definitions of article 5.