Release of BEPS discussion draft: Preventing the Artificial Avoidance of PE Status
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Tax Policy Bulletin
Tax Insights from International Tax Services & Transfer Pricing
Release of BEPS discussion draft:
Preventing the Artificial Avoidance
of PE Status
3 November 2014
In brief
Fundamental changes to the existing Permanent Establishment (PE) rules, with a potentially wide
impact on many structures currently in use by MNCs are proposed in the OECD discussion draft on BEPS
Action Step 7 (Preventing the Artificial Avoidance of PE Status) published on 31 October 2014. Although
one of the shortest papers so far released, the various options proposed in the draft, which include
widening the dependent agent provisions and narrowing both the independent agent exemptions and the
specific activity (e.g., warehouses, etc.) exemptions, go beyond the PE areas identified for review under
Action 7 in the original BEPS Action Plan. It seems clear that the broad reach of many of the options
reflects the concerns raised in the BEPS Report on the Digital Economy regarding the ability of
companies to market products and services in a host country without a meaningful physical presence.
There are five separate areas in which the OECD is proposing change:
Commissionaire arrangements and similar strategies
A variety of issues relating to the specific activity exemptions, including the operation of the
“preparatory or auxiliary” test and the ability of companies to fragment activities
Rules to counter the splitting up of contracts
Specific insurance sector PE proposals
PE profit attribution issues
Unlike some of the earlier OECD papers that have been released, the general approach of the PE
discussion draft is to offer alternative approaches to deal with the issues identified. The overall tone of
the paper is a little more cautious than earlier papers (where typically no such alternative approaches
were canvassed), perhaps reflecting not only the inherent difficulties in many of the proposals but also
the inevitably charged and ultimately political nature of many of the proposals. As is noted in the paper,
the proposals in the discussion draft do not represent the consensus views of the OECD but are intended
to facilitate analysis and comment by stakeholders. Nonetheless, a trait of all the proposals is clearly to
reduce the existing PE threshold.
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In detail independent agent exemption (Art 5 relationship between that person
(6) of the OECD Model). These and the enterprise, are on the
The first two areas of the discussion options are based on the OECD’s view account and risk of the enterprise”.
draft will, in particular, be of material that “in many cases commissionaire
relevance to a wide body of taxpayers The discussion draft explains that
structures were put in place primarily the intention behind the substitute
and will introduce real risks of in order to erode the taxable base of
collateral impact. The third and fourth wording proposed is to refer to
the state where sales took place”.
areas are aimed at particular sectors. contracts that are on the account
The final area identifies some of the The policy underlying all of these and risk of the foreign enterprise
difficulties with attributing an alternatives is that where the activities by virtue of the legal (not
appropriate amount of profit to PEs that an intermediary exercises in a economic) relationship between
which would be created as a result of country are intended to result in the that person and the intermediary
these changes. regular conclusion of contracts to be or agent – e.g. a relationship
performed by a foreign enterprise, created by an agency contract, a
Commissionaire arrangements that enterprise should be considered
commissionaire contract, a
Commissionaire arrangements are to have a sufficient taxable nexus in
explained in the discussion draft as partnership agreement, etc.
that country unless the intermediary
arrangements through which a person is performing these activities in the The requirement of “independence” in
sells products in a given state in its course of an independent business. the independent agent exemption is
own name but on behalf of a foreign That result is delivered by all four also strengthened by the requirement
enterprise that is the owner of these drafting alternatives that are included that the agent must act for “various
products. Through such an in the discussion draft. persons” and in the ordinary course of
arrangement, a foreign enterprise is that business and also must not act
able to sell its products in a state The four alternatives each present
exclusively or almost exclusively on
without creating a PE to which such different permutations of approaches
behalf of one enterprise or associated
sales may be attributed for tax to two key problems with the current
enterprises. This restrictive version of
purposes. The person doing the selling drafting of the dependent agent rule.
the independent agent exemption is
(the commissionaire) in the state also included in all of the four
The first perceived problem is the
concerned would typically be taxed on alternatives discussed above.
wording “concludes contracts”. On
the remuneration it receives for its
services (often a commission) rather this point, two alternatives are Comment: The overall approach of
than on the profits derived from such suggested. The first is to replace lowering the dependent agent
sales. this wording by a test of whether threshold below the “concluding
the agent concerned “engages with contracts” test is likely to appreciably
These arrangements have been a specific persons in a way that widen the scope of the rule and
concern to a number of tax authorities results in the conclusion of introduce greater subjectivity into the
for a number of years and certainly determination of whether a PE exists
contracts”. The second alternative
before the BEPS project. This in any particular case. In particular,
is similar except that it addresses
explains why the “commissionaire” the current drafting would seem to go
issue has now become one of the situations where contracts may not
far beyond the “commissionaire”
higher profile issues within BEPS and be formally concluded. This is
model and potentially impact a wide
why Action 7 of the BEPS plan achieved by the introduction of the range of arrangements for making
required a policy re-evaluation of the words “concludes contracts or who direct sales or providing sales support.
existing PE rules in relation to such negotiates the material elements of This seems likely to include limited
commissionaire arrangements and contracts”. risk distributor and other principal
similar strategies. structures. Equally, the narrowing of
The second perceived problem
the independent agent exemption will
Four alternative options are put concerns the wording in the
also expand the scope of the
forward to amend the dependent existing dependent agent test of dependent agent rule. The
agent PE rules (Art 5 (5) of the OECD “contracts in the name of the independent agent options would in
Model) in order to deal with these enterprise”. It is proposed that this addition eliminate a long standing
arrangements and in addition these would be changed to “contracts principle that an agent can be
alternatives also tighten up the
which, by virtue of the legal independent even if it acts exclusively
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for one party or one or more affiliated for the delivery of goods (i.e. a the scope of the exemption for
enterprises if appropriate criteria are warehouse) in which a significant collecting information for the
met. In addition to expanding the number of employees work for the enterprise by disguising what is in
coverage of the dependent agent rule, main purpose of delivering goods reality the collection of
the proposal would mean that an that the enterprise sells online. information for other enterprises
office used by an agent that falls by repackaging the information
That leads to the option for the
outside the independent agent collected into reports prepared for
general removal of the exemption these enterprises.
definition could be viewed as an office
at the disposal of the principal. for the use of facilities for the
delivery of goods or merchandise Finally, the fourth option, which is
Specific activity exemptions belonging to the enterprise. independent of the above options,
The reference to “specific activity” However, the discussion draft itself is concerned with the
exemptions is a reference to the list of seems reluctant to endorse this fragmentation of activities between
exceptions in Art 5 (4) of the OECD approach, noting that, even if a PE related parties. The discussion
Model, according to which a PE is is created by facilities used to draft notes that the Commentary to
deemed not to exist where a place of deliver goods or merchandise the OECD Model already addresses
business is used solely for activities
belonging to the enterprise, the the fragmentation of activities in
that are listed in that paragraph. The
resulting measure of attributable clarifying that a (single) enterprise
discussion draft examines four aspects
profit may not be particularly “cannot fragment a cohesive
of the Art 5 (4) rules, in each case
providing options to counter aspects significant and tax authorities operating business into several
that the Working Group sees as might be led into attributing too small operations in order to argue
potentially giving rise to the artificial much income to this activity if they that each is merely engaged in
avoidance of the PE threshold. The do not give the issue close preparatory or auxiliary activity”.
main targets are warehouses, consideration, leading to litigation The discussion draft seeks to go
purchasing offices, and offices used and inconsistent application of tax beyond this “given the ease with
for the gathering of information. The treaties. which subsidiaries may be
second and third options proceed on established”. This leads to two
the basis the first option, below, is not The third option addresses the PE
alternative options.
implemented and they therefore exemption for the maintenance of
target particular exemptions on which a fixed place of business solely for – Under the first, the anti-
the OECD has BEPS concerns. the purpose of purchasing goods or fragmentation rule denying a
merchandise or collecting PE exemption is extended to
The first option is to make all of
information for the enterprise. cases where complementary
the activities currently listed in the
There are in turn two alternative business activities are carried
provision as subject to the approaches proposed for this rule– on by associated enterprises ,
requirement of being “preparatory
regardless of residency, at the
or auxiliary”. This would mean – the first, to delete the entire
same location, or by the same
that it would not, for example, be provision;
enterprise or by associated
sufficient for facilities to be used – the second, to retain the enterprises at different
solely to deliver goods or exemption for collecting locations. For the rule to
merchandise belonging to the information but delete the apply a group of associated
enterprise (notwithstanding the exemption for purchasing enterprises must have at least
current drafting of the provision) goods or merchandise. one fixed place of business
unless in each case the activity that satisfies the PE threshold
concerned also could meet the The alternative options are based
on the view in the discussion draft and the activities concerned
proposed overriding “preparatory
that there is, at a policy level, must be “complementary
or auxiliary” test. functions that are part of a
insufficient justification for the
The second option is based on the exemption for purchasing goods cohesive business operation”.
observation in the discussion draft or merchandise and also there
– The second option is similar
that it is difficult to justify the are concerns that some
enterprises have sought to extend to the first except that it also
exemption for facilities used solely
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applies where none of the designed to cover a period of less than in the PE rules. It is very likely that
places to which it refers 12 months) to a different company in this would in practice lead to a
constitutes a PE but the order to avoid the existence of a PE. materially increased uncertainty as to
combination of the activities the application of the PE definition
Here, two alternative options are put rules as a whole. The discussion draft
at the same place or at forward to deal with what is described explains that the anti-abuse rule
different places go beyond as abuse of the Art 5 (3) test. would apply only to tax-motivated
what is preparatory or
Under the first approach, there cases and not where there are
auxiliary. legitimate business purposes for the
would be an “automatic” rule to
Comment: The options are likely to involvement of associated enterprises,
take account of activities
create additional sources of but this distinction is likely to prove
performed by associated highly contentious in practice.
controversy and may have unintended
enterprises in arriving at an
consequences in some areas. If the
aggregate period of time for the Specific insurance sector PE
option to remove the exemption for
purposes of the 12 month rule. proposals
the delivery of goods is adopted, the
OECD Model Commentary will need One of the more surprising areas on
The second approach involves the
to make clear when storage/display which proposals have been developed
application of the treaty general (because it has nothing to do with the
ends and when delivery (which creates
anti-abuse rule (i.e. the “Principal specific PE issues identified in the
a PE) starts, in order to bring
Purpose Test” rule), developed original BEPS Action Plan) is the
certainty. With regard to the anti-
fragmentation options, the approach under the Action 6 work on treaty inclusion of options to deal with
of combining activity not just of a abuse, in relation to which there is insurance agents, even though they do
given legal entity but also of related proposed the addition in the OECD not conclude contracts for their
parties to assert a PE is created may Commentary of a new example to principal. There are two alternatives
lead to material increase in highlight the availability of that presented to achieve this goal. The
uncertainty and subjectivity as regards rule to counter this instance of first proposal, which seems to have
what is to count as a “cohesive been modeled on the UN Model, is
perceived PE abuse.
operating business” and would also that insurance companies would be
give source countries an ability to Comment: Careful consideration of deemed to have a PE in a state where
pierce or ignore the separate legal the first alternative will be necessary either they collect premiums through
personality of substantive legal as, in the absence of any further an agent established in that state or
entities. qualification, a range of different where they insure risks situated in
activities within a single MNC group that territory through such an agent.
Rules to counter the splitting up might be aggregated where there is If the agent is an independent agent,
of contracts arguably no abuse of the sort that is the rule would not apply. The
The options to counter the splitting up envisaged (e.g. specialist technicians discussion draft explains that the
of contracts are of relevance to the visiting a site to conduct feasibility provision suggested is already found
specific 12 month PE rule for studies in advance of a local in many treaties with some variations
construction sites in Art 5(3) of the subsidiary acting as contractor). This and it can be seen as merely extending
OECD Model (though it is noted in the could be a particular challenge for an the scope of the agency PE rule where
discussion draft that the splitting up MNC group that is diversified and premiums are collected or risks
of contracts is also a concern with the decentralised as they may be unaware insured through a person other than
application of service PE provisions, of all the activities of the MNC group. an independent agent even if
such as the alternative provision The second alternative seems much insurance contracts are not concluded
found in the OECD Model less welcome given that the by that person. Under the second
Commentary and in Art 5 of the UN implication is that, notwithstanding alternative, no specific rule would be
Model). the suggestion of inserting a specific added and the position of insurance
example in the Commentary, tax enterprises would be dealt with
The OECD’s concern is that authorities may be encouraged to through the more general changes
construction contracts may be make much more active and regular proposed to Art 5(5) and 5 (6) (as
artificially divided or split up with the use of the treaty Principle Purpose discussed in relation to
intention of allocating the resulting Test (PPT) and therefore further commissionaire arrangements above).
split contracts (each of which being undermine any residual certainty left
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Comment: In connection with the (interest deductions), Action 8 international standards on the
first alternative on insurance agents, (intangibles) and Action 9 (risks and allocation of taxing rights on cross
there is no explanation in the capital) will all need to be considered border income.
discussion draft on why, in the in this regard and that the work on
absence of these sector-specific special risk and capital in particular might However, with its lowering of the PE
provisions, there would be “artificial involve a reconsideration of some threshold and narrowing of available
avoidance of the PE threshold in aspects of the existing rules and exemptions, it is inevitable that the
relation to insurance activities”. The guidance on attribution. proposed PE changes will lead to a
obvious question is what rationale (or material shift towards source-based
criterion) supports the development Comment: Perhaps the biggest taxing rights.
of special rules for the insurance omission of the PE discussion draft is
any substantive discussion on the Another important consequence of the
sector and no other sector? In proposals is likely to be a material
relation to the second alternative, critical question of what the expanded
scope of the PE definition will mean in increase in uncertainty given the
though brought forward as a specific greater use of subjective tests in what
rule to address the insurance sector, it terms of the attribution of profits to
the “new” PEs created. The discussion is proposed, coupled with the already
does in fact make no distinction problematic (because vague and in
between an insurance enterprise and draft seems to proceed largely on the
basis of an expectation of an increase many cases uncertain) attribution
any other enterprise and thereby rules. This means that if the options
seems to undermine the need for any in profits to such PEs over existing
transfer pricing arrangements but the in the discussion draft are largely
special rule as is proposed by the first adopted the existing strained dispute
alternative. In any event, this precise reasoning (for example, by
reference to the terms – or an resolution system will come under
proposed extension of the PE increasing pressure.
definition would not apply where the amendment to the terms – of the PE
insurance contracts concerned are re- attribution rules) is not included. In consequence, alternative means of
insurance contracts. Given the proposed changes to the PE preventing and resolving disputes and
definition and the (presumed) audits should be given a high priority,
PE profit attribution issues intention to attribute profits to at least for example in the expansion of
The discussion of profit attribution to some of these newly-created PEs, it advance ruling processes, etc. These
PEs is very short even though it is seems likely that significant changes could include both the initial
recognized in the discussion draft that to the treatment of risk may be determination of the existence of a PE,
the issue is of key importance in proposed by the work on risk and as well as the allocation of profits to
determining what changes should be capital under point 9 of the BEPS that PE.
made to the definition of the PE test. Action Plan.
It is noted that the preliminary work Enhanced dispute resolution options
done so far indicates that no
The takeaway such as administrative appeals,
substantial changes are needed to the The discussion draft states that the mediation and arbitration should also
existing attribution rules (in Art 7 of OECD’s actions to address BEPS are be developed. Without such changes,
the OECD Model) though clearly some intended to restore, not change, there is a real prospect of a dramatic
changes are contemplated by the source and residence taxation rights increase in the incidence of PE audits
BEPS PE work. However, it is and the actions proposed are not and disputes with potentially double
stressed that the work on Action 4 directly aimed at changing the existing taxation and years of uncertainty as
the outcome.
5 pwcTax Policy Bulletin Let’s talk If you’d like to discuss these issues further please call your usual PwC contact or one of the following: Richard Collier, London Ulf Andreson, Frankfurt Jerome Monsenego, Stockholm +44 207 212 3395 +49 69 9585-3551 +46 10 2133483 richard.collier@uk.pwc.com ulf.andresen@de.pwc.com jerome.monsenego@se.pwc.com Mike Gaffney, New York Steve Nauheim, Washington David Ernick, Washington +1 (646) 471 7135 +1 (202) 414 1524 +1 (202) 414 1491 mike.gaffney@us.pwc.com stephen.a.nauheim@us.pwc.com david.ernick@us.pwc.com David Swenson, Washington Alex Voloshko, Boston Alenka Turnsek, London +1 (202) 414 4650 +1 (617) 530-4512 +44 20 7213 5045 david.swenson@us.pwc.com alex.voloshko@us.pwc.com alenka.turnsek@uk.pwc.com Phil Greenfield, London +44 207 212 6047 philip.greenfield@uk.pwc.com © 2014 PricewaterhouseCoopers LLP, a Delaware limited liability partnership. All rights reserved. PwC refers to the United States member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. SOLICITATION This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. 6 pwc
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