Strategizing International Tax Best Practices – by Keith Brockman

Archive for the ‘PE’ Category

India PE: Profit proposal

India’s Central Board of Direct Taxes has published a report for comments, due by May 18th.

The Committee has recommended a mixed or balanced approach (“fractional apportionment”) that allocates profits between the jurisdiction where sales take place and the jurisdiction where supply is undertaken.  India’s position is that such approach is acceptable in other tax treaties.  However, the risk of double taxation is present if this approach is not adopted by other countries.  Additionally, the approach differs from the OECD approach, which then introduces more complexity for all multinationals with Indian operations.  

India is known for its long appeals, and different approaches to its fisc.  Accordingly this report should be reviewed, with a possibility to comment, prior to further actions.  This report, and methodologies, will also be closely followed by other countries in this complex and subjective area of PE profit allocations.

EY’s Global Tax Alert provides additional details, for reference.

Click to access 2019G_001978-19Gbl_TP_India%20-%20Proposal%20to%20amend%20PE%20profit%20attrib%20rules.pdf

Italy: New web tax & PE

The Italian Budget has enacted a 3% web tax, and a new PE definition based on economic, vs. physical, presence.

The Tax is due by the buyers of the above services unless the supplier declares in the invoice that it has not reached the threshold of 3,000 transactions in the calendar year.

The PE definition goes beyond the OECD’s intent, and will certainly lead to additional disputes in Italy and other countries developing such a subjective measure that also attracts double taxation.

EY’s global tax alert provides additional details as reference.

Click to access 2017G_07179-171Gbl_Italy%20enacts%20Web%20Tax%20and%20new%20PE%20definition.pdf

Place of effective management: India’s creativity anew

India’s Ministry of Finance has issued draft guiding principles for determining the place of effective management (POEM).  The Finance Act of 2015 contained provisions providing for the significant change in determining POEM, to be effective April 2016.  The guidelines have a comment period until 2 January 2016; a link to the guidelines is provided:

Click to access POEM-note-for-uploading.pdf

The guidelines present subjective determinations of determining POEM based on substance over form and a recurring annual test.  There are presumptions, such as location for a majority of Board meetings, with exceptions based on facts and circumstances.

As drafted, the new guidelines present increased uncertainty for multinationals having any operations or services with Indian residents, thus this latest report should merit high priority due to the April 2016 effective date, as well as brief period provided for comments.

 

 

Kuwait: Virtual Service PE

Kuwait’s Department of Inspections and Tax Claims (DIT) has introduced its interpretation of a Virtual Service PE, notwithstanding its nonconformity with the physical presence standard and its double tax treaties in accordance with OECD’s Model Convention.

Unfortunately, this concept is not new in the Middle East and it is hoped that other countries will not follow this breakaway interpretation.

EY’s Global Tax Alert provides additional details into this development:

Click to access 2015G_CM5779_Kuwait%20Tax%20Authorities%20adopt%20Virtual%20Service%20PE%20concept.pdf

Key observations:

  • The Virtual Service PE concept takes into account only the duration of the contract itself.
  • Work extending beyond the tax treaty threshold of 183 days will be presumed to have created a Service PE.
  • The DIT takes the position that a nonresident is deemed to have a PE in Kuwait, particularly, if the following conditions are met:
    • A nonresident furnishes services to an entity in connection with the latter’s activity in Kuwait.
    •  The period during which such services are rendered according to the contract, exceeds the threshold period under the applicable tax treaty.

The immediate implication of the DIT’s current approach to a “Virtual Service PE” is that the applicability of tax treaty-based income tax exemptions with respect to cross-border services has become highly uncertain.

Accordingly, all legal agreements and provision for services to Kuwait (disregarding the physical standard) should be reviewed for potential disputes based on a Virtual Services PE argument.  Practically, it may also be difficult to obtain tax treaty relief from double taxation.

 

Saudi Arabia: Virtual PE

Saudi Arabia’s Department of Zakat and Income Tax (DZIT) has issued internal guidelines defining a creative concept of Permanent Establishment (PE) that is not aligned with its legislated tax law, double tax treaties, OECD or UN Model Conventions.

This new approach may affect treaty-based withholding tax exemptions, as well as refunds.  Saudi Arabian customers may apply the domestic withholding tax rate as a result, thereby requiring the non-resident to apply for a tax refund.

EY’s Global Tax Alert provides additional details about this latest development:

Click to access 2015G_CM5642_Saudi%20Arabian%20tax%20authorities%20introduce%20Virtual%20Service%20PE%20concept.pdf

The PE definition, and related legislative thresholds, are being aggressively contested by various countries in an effort to capture additional taxes that have been paid in other jurisdictions.  However, such provisions usually have no offsetting adjustment for simultaneous relief from double taxation.  It is expected to see this trend continue, at least partially incentivized by OECD’s BEPS Acton Plans that have yet to be finalized.

The PE pursuits should be closely monitored, with the expectation that assessments will be issued and further appeals will be necessary to fairly address the issue within the intended legal context of that jurisdiction.

European Commission’s Tax Transparency Package: new era

The European Commission published a package of tax transparency measures on 18 March 2015.  The press release and other documents, linked herein for reference, include a tax transparency communication, Council Directive re: automatic exchange of information and Q and A’s of the comprehensive package. Significant initiatives are included in this package addressing corporate tax avoidance and harmful tax competition in the EU, key components of which are highlighted. http://europa.eu/rapid/press-release_IP-15-4610_en.htm http://ec.europa.eu/taxation_customs/resources/documents/taxation/company_tax/transparency/com_2015_136_en.pdf http://ec.europa.eu/taxation_customs/resources/documents/taxation/company_tax/transparency/com_2015_135_en.pdf http://europa.eu/rapid/press-release_MEMO-15-4609_en.htm Press release:

  • The concepts of tax evasion, corporate tax avoidance, “pay their fair share,” aggressive tax planning and abusive tax practices are summarily stated, although corollary concepts for avoidance of double taxation and effective dispute resolution are noticeably absent.
  • Tax rulings will be automatically exchanged every 3 months.
  • Feasibility of public disclosure of certain tax information of MNE’s will be examined.
  • The EU Code of Conduct on Business Taxation will be reviewed to ensure fair and transparent tax competition within the EU.
  • The Savings Tax Directive is proposed to be repealed to provide efficiencies and eliminate redundant legislation in the Administration Cooperation Directive.
  • Next steps: The tax rulings proposal  will be submitted to the European Parliament for consultation and to the Council for adoption, noting that Member States should agree on this proposal by the end of 2015, to enter into force 1/1/2016.
  • Common Consolidated Corporate Tax Base (CCCTB) proposal will be re-launched later this year.

Tax Transparency proposal:

  • Existing legislative framework for information exchange will be used to exchange cross-border tax rulings between EU tax authorities.
  • The Commission will develop a cost/benefit analysis for additional public disclosure of certain tax information.
  • The tax gap quantification will be explored to derive more accuracy.
  • The global automatic exchange of information for tax rulings will be promoted by the EU.

Council Directive (amending Directive 2011/16/EU) re: automatic exchange of information:

  • Mandatory automatic exchange of basic information about advance cross-border rulings and advance pricing agreements (APAs).
  • Article I definition of “advance cross-border ruling:
    • any agreement, communication, or any other instrument or action with similar effects, including one issued in the context of a tax audit, which:
      • is given by, or on behalf of, the government or the tax authority of a Member State, or any territorial or administrative subdivisions thereof, to any person;
      • concerns the interpretation or application of a legal or administrative provision concerning the administration or enforcement of national laws relating to taxes of the Member State, or its territorial or administrative subdivisions;
      • relates to a cross-border transaction or to the question of whether or not activities carried on by a legal person int he other Member Sate create a permanent establishment, and;
      • is made in advance of the transactions or of the activities in the other Member State potentially creating a permanent establishment or of the filing of a tax return covering the period in which the transaction or series of transactions or activities took place.
  • Automatic exchange proposal is extended to valid rulings issued in the 10 years prior to the effective date of the proposed Directive (Article 8a(2)).
  • In addition to basic information exchanged, Article 5 of the Directive should provide relevant authority for the full text of rulings, upon request.
  • EU central repository to be established for submission of information by Member States.
  • Confidentiality provisions should be amended to reflect the exchange of advance cross-border rulings and APAs.

Q and A’s:

  • Corporate tax avoidance, as explained, undermines the principle that taxation should reflect where the economic activity occurs.
  • Standard/template information for the quarterly exchange of information includes:
    • Name of taxpayer and group
    • Issues addressed 
    • Criteria used to determine an APA
    • Identification of Member States most likely to be affected
    • Identification of any other taxpayer likely to be affected
  • Commission could open an infringement procedure for Member States not following the disclosure obligations.
  • Domestic tax rulings are exempt.
  • The EU could be a global standard setter of tax transparency.
  • The EU Code of Conduct criteria are no longer adequate, and it lacks a strong enough mandate to act against harmful tax regimes.

The EU Tax Transparency Package is required reading for all MNE’s and other interested parties, as it is an ambitious effort to provide globally consistent procedures for the exchange of tax rulings/APAs. Additionally, it is interesting to note the EU’s aggressive actions and timing in its efforts to align, as well as expand, the OECD’s efforts to address BEPS Action Items.  These actions are also intended to be a standard for global setting in the new era of international tax transparency.     As a Best Practice, the 10-year look-back provision for rulings implies that MNE’s should have a similar central database for prior, and future, cross-border rulings.  Additionally, this automatic exchange is another element of consideration prior to formally requesting a tax ruling.    

BEPS Action 7 / PE: TEI’s comments

Tax Executives Institute, Inc. (TEI) has provided comments in response to OECD’s BEPS Action 7: Preventing the Artificial Avoidance of PE Status.

Click to access TEI%20Comments%20-%20OECD%20BEPS%20Action%207%20PE%20-%20FINAL%20to%20OECD%2023%20December%202014.pdf

Key observations:

  • Changes to the definition of a Permanent Establishment (PE) are more welcome in the Model Convention, as recommended, rather than modifying the official commentary.
  • Continued focus on physical presence in the general definition of a PE is commended.
  • “The Discussion Draft generally views commissionaires as structured “primarily” to permit MNEs to erode the tax base of the State of sale.” However, there is no mention of the legitimate arrangements for which they are used.
  • Four amendments are proposed, each of which would likely eliminate the commissionnaire arrangement and increase uncertainty.
  • The new paragraph 6, broadening the definition of an independent agent, is vague and problematic.  This change may result in a subsidiary being a dependent agent of the parent in a limited risk distributor situation, resulting in PE of the parent.
  • The proposed anti-fragmentation rules for a PE exception are subjective and increase uncertainty.
  • The Authorized OECD Approach (AOA) for determining a PE’s profits are complex and uncertain.
  • There are no transition periods or grandfathering provisions for implementation of the new PE definition.

TEI’s commentary is well written and poses practical arguments that should be considered by the OECD.  Accordingly, it is a document that should be required reading for all tax practitioners involved in transfer pricing.  The proposed changes will also affect other aspects of transfer pricing and BEPS Actions that will be finalized this year.

OECD comments: PE avoidance strategies

OECD has published the “only” response received  for its work on BEPS Action 7 (Artificial Avoidance of PE Status) from a Chartered Accountant in India, outlining strategies that may result in the artificial avoidance of PE status re: base erosion and profit shifting.  The comment discusses a few measures generally adopted by multinationals to avoid PE in the source jurisdiction.  The link is provided herein for reference:

http://www.oecd.org/ctp/treaties/oecd-publishes-comments-on-strategies-allegedly-resulting-in-artificial-avoidance-of-pe-status.htm

The examples, and short references to the comments, detail the following “artificial measures” to avoid PE:

  • “Preparatory and auxiliary activities” exception: processing of goods exception may require review as “auxiliary” in character
  • Agent PE: local entity  appointed as “agent” acting on behalf of foreign multinational, high threshold of definition restricting tax authorities
  • Independent Agent: activities of Principal, multiple Principals
  • Professional service provider: definition requires substantial amendment
  • PE definition and “permanency”: developing a “negative list” category re: performance of activities in source countries
  • Income attribution and transfer pricing: Broaden PE scope/lower PE threshold, electronic commerce reference

As PE is a hot topic that is being undertaken by the OECD, this comment should be reviewed, especially due to the fact that it is the only response received.

PE Best Practices Risk Review: BEPS Action Plan, OECD & UN Model Conventions

A Permanent Establishment (PE) risk review is an integral component of a global Tax Risk Framework, increasing in importance with issuance of the OECD Base Erosion and Profit Shifting (BEPS) Action Plan.  The PE risk review should be monitored on a recurring basis against the backdrop of current and future developments.  The OECD and UN Model Conventions, with related Commentaries, provide insight into the development and current state of international PE guidelines.  The Conventions provide a useful framework to document specific PE criteria, and exceptions thereto, for risk analysis.

Action 6 (Prevent Treaty Abuse) of the BEPS Action Plan states that the definition of PE must be updated to prevent abuses.  Action 7 (Prevent the artificial avoidance of PE status) provides additional PE initiatives.  Actions 6 and 7 are designed to implemented by September 2014 and September 2015, respectively.  It will be paramount to note any changes in the “preparatory or auxiliary” exception.  A link to the BEPS Action Plan is hereby provided for reference:  http://www.oecd.org/ctp/BEPSActionPlan.pdf

Article 5 of the OECD Model Convention provides an outline for PE determination, including a “fixed place of business” standard, building site or installation project criteria, the “preparatory or auxiliary character” exception, dependent agent rules and further exceptions for activities of an independent agent and related entities.  The OECD Model Convention can be accessed at: http://www.oecd.org/tax/treaties/oecdmtcavailableproducts.htm

The OECD Commentaries are required reading to fully comprehend the history, and intended meaning, of Article 5.  Paragraph 2 of the Commentary provides an outline for determination of a “fixed place of business,” consisting of (i) the existence of a “place of business,” (ii) this place of business must be “fixed,” and (iii) the carrying on of the business through this fixed place of business.  Paragraph 24 of the Commentary states that , for application of the “fixed place of business” rule, “the decisive criterion is whether or not the activity of the fixed place of business in itself forms an essential and significant part of the activity of the enterprise as a whole.”  Paragraph 33 further provides that “the authority to conclude contracts must cover contracts relating to operations which constitute the business proper of the enterprise.”

The attached reference provides access to the UN Model Convention, Letter from India (13 Aug 2012), revised commentary on existing Article 5 and definition of PE for comprehensive understanding of the current PE Article.  The UN Model Convention contains an Introduction, Part One (including the Articles), and Part Two with Commentaries.  Paragraph 20 of the Commentaries states that the Commentaries on the Articles are regarded as part of the UN Model Convention, along with the Articles themselves.  Most importantly, Part Two cites differences of the UN and OECD Model Conventions, such as the UN inclusion of a services standard, exceeding 183 days in any 12-month period, that is not within the OECD guidelines.   http://www.un.org/esa/ffd/tax/unmodel.htm

Best Practice ideas for outlining PE risk include:

  • Documenting potential significant PE risks by legal entity, with specific reference to the PE attribute that attracts such risk, such as a fixed place of business or dependent agent.
  • Outlining availability of the preparatory or auxiliary character exception for potential risks.
  • Inclusion of objective and subjective evidence that provides defense for a potential PE determination, including wording from the applicable Convention and Commentaries.
  • Tools available to reduce double taxation upon determination of a PE, such as the Mutual Agreement Procedure (MAP).

The above Best Practices should be combined with Best Practice ideas in former posts:

  • 14 April PE Risks: Best Practices for Awareness & Planning
  • 14 July: PwC PE survey: Trends & Challenges

PE determination is increasing in importance in today’s changing tax world, thus a detailed risk matrix is essential to determine current potential risk areas, as well as provide valuable information to assess proposed changes by the OECD and/or UN.

PwC PE survey: Trends & Challenges

http://www.pwc.com/gx/en/tax/publications/permanent-establishments.jhtml

PwC has published results from a survey of more than 200 multinationals in Europe and the U.S., focused on Permanent Establishment (PE) challenges and trends.

Survey results include the following:

  • 86% cite increased mobility as a significant trend in triggering PE risk.
  • Difficulty in monitoring business activities, after PE guidance is provided.
  • Do’s and Don’ts provisions are hard to manage.
  • Audit readiness checks should be conducted to reduce PE risk.
  • Tax authorities are exhibiting more aggressiveness in assertions of PE, primarily focused in Europe.
  • Site visits and employee interviews are techniques used more often by tax authorities to identify risks.

My prior posts encompassing PE trends and Best Practices should be reviewed, including 14 April PE Risks and Best Practices, 24 April Global Mobility Alignment, 11 May and 20 May Branch activity risks.

Examples of Best Practices:

  • Confirmation of PE awareness and controls annually by CFO’s / Business Leaders, including Branches and emerging markets
  • PE template to facilitate audit readiness checks
  • PE internal reference guide
  • PE workshops with Internal Audit, Global Mobility and Business Leaders discussing examples of PE and addressing adequacy of controls
  • Discussion of PE cases in the media with regional and global tax teams to accurately and timely inform business leaders

PE risk is still increasing, thus additional focus should be directed to minimize this risk and integrate controls into the Tax Risk Framework.

Google UK: PE Risk – Do no evil

http://www.reuters.com/article/2013/05/16/us-google-britain-tax-idUSBRE94E0WL20130516

In continuing verbal encounters by Google UK before the Parliament’s Public Accounts Committee (PAC), it is interesting to note the following in the above article, supplemented by similar language in the related articles cited below:

  • The company evidently stated that “We are selling, but not closing.”
  • The article cites the fact that a review of LinkedIn profiles revealed sales activities were conducted by employees.
  • The article does not provide the reader a concise description of PE, or its safe harbors in Double Tax Treaties: re: “preparatory and auxiliary activities.”

This arduous lesson in reputational risk reinforces the need to ensure Best Practices are in place for PE, as posted in a prior blog.

It is a very interesting point that LinkedIn profiles were reviewed to further examine potential sales activities carried out in the UK.  A company cannot control the social network profiles of its employees, although it should be very clear in everyone’s job description what is, and is not, allowable for marketing or sales activities.  The Do’s and Don’ts List should be signed annually as a reminder to employees of their responsibilities and limitations in scope.

A company with significant Branch activities should be reviewing how written statements, including emails, are communicated in  discussions of sales, market support or promotional activities.

The statement “We are selling, but not closing” brings a substance vs. form argument into the subjective definition of PE, an argument that is not helpful in forming objective arguments by the company or tax authorities.  Therefore, a company should examine its Best Practices to increase its objective PE evidence, in substance and form, in preparation for controversy.

Does your Tax Risk Policy include any statements re: whistleblower activity, and how such activity should be addressed?

Finally, a company should conduct an annual audit of its significant Branch activities, in possible coordination with internal audit, to further minimize its PE (and reputational) risk on an annual basis.

Branch activity tax risk: Google UK controversy

http://news.yahoo.com/uk-lawmakers-set-date-google-ernst-young-tax-155316417.html

As this news has been widely reported, this controversy highlights the need to aggressively govern the activities of significant Branches worldwide.  This issue is a reminder in today’s tax environment of the necessity for diligence and governance for Branch operations.  The following ideas are presented for review and comment.

  • Review all material on your company’s website re: location of sales activity, associates and job postings.
  • Review job titles and descriptions for all personnel in Branches worldwide.
  • Compare Branch accounts and related disclosures with actual activities on an ongoing basis for consistency.
  • Have a Do’s and Don’ts list that is reviewed annually with individuals having market support activities.
  • Align with Global Mobility re: assignments/transfers of individuals to Branches with Sales titles and responsibilities.
  • Compare actual activities with the legal constraints of a Branch in the relevant jurisdiction.
  • Put a plan in place to regularly determine if a Branch is the best legal form of conducting business, vs. subsidiary, etc.
  • Conduct annual trainings at significant Branches to ensure the activities align with the legal form of doing business.
  • Ensure the concept of PE is well understood by individuals accountable for the Branch operations.
  • What job titles are individuals allowed to include on their business cards?
  • How do Branch personnel represent themselves to the external trade?
  • Is there an objective benchmark (i.e., number of personnel) for Branches that triggers an automatic review?
  • Review the relevant Double Tax Treaty safe-harbor PE provisions.
  • Reputational risk: Consider how Branch activities impact the Tax ERM framework, and monitoring controls in place.

It will be interesting to track the activities of this controversy and analyze how to further minimize risks for Branch activities.

PE Risks: Best Practices for Awareness & Planning

Permanent Establishment (PE) risk is receiving increased visibility around the world, in established countries and emerging markets.  Therefore, have you increased your focus to strategize Best Practices to minimize this risk?  The following ideas are presented for consideration:

  • Coordination of employee transfers/assignments to understand new roles and responsibilities, legal entities, etc.
  • PE global training to increase awareness, collaborating with the Human Resource function.
  • Review tax treaties for all business changes to understand PE triggers and exceptions.
  • Utilizing special purpose entities to centralize, or isolate, potential risks.
  • Developing a Do’s and Don’ts list to discuss with the business; attach to Job Descriptions, as applicable.
  • Formal PE technical training, at least annually, for all employees having international tax responsibilities.
  • If consideration of PE risk is coordinated by external advisors, develop a collaboration plan to review regularly.
  • “Presence” test PE safe harbor, dependent on treaty: Who is counting the days and coordinating related steps of a project?
  • “Preparatory & Auxiliary” PE treaty exception: review Form vs. Substance on a recurring basis.
  • Develop PE expertise and clarify roles of internal staff and external advisors.
  • Proactive vs. reactive PE determinations, understand when a proactive PE determination may be beneficial.
  • Follow PE trends of aggressive jurisdictions with scenario planning.
  • Collaborate with the business to understand upcoming strategies that may introduce new PE risks.
  • Review “Branch” activities annually to determine if they exceed allowable actions in the respective countries.
  • Establish a collaborative process for entry into new countries to ensure tax coordination and risk identification.
  • Ensure a communication protocol is established for response to PE allegations that are made public.
  • Following current events for OECD and UN model conventions, as well as related commentaries
  • Identification, with mitigating controls, in tax risk  and ERM framework
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