Strategizing International Tax Best Practices – by Keith Brockman

Posts tagged ‘PE’

EU Council: New Directive

The EU Council has provided a Directive that would introduce legislation ensuring the EU maintains its leadership role in anti-BEPS recommendations, as well as providing good tax governance for the rest of the world.  EY’s summary of the Directive is provided for reference:

Click to access 2015G_CM6047_EU%20Council%20adopts%20directive%20on%20exchange%20of%20info%20on%20tax%20rulings,%20agrees%20on%20other%20corporate%20tax%20issues.pdf

Key points:

  • Automatic exchange of tax rulings would be effective 1/1/2017.
  • Changes would be introduced for the EU Code of Conduct.
  • EU anti-BEPS proposal to include the following BEPS Actions:
    • 2: Hybrid mismatches
    • 3: CFC rules
    • 4: Interest limitations
    • 6: General anti-abuse rule (noting its inclusion for the Royalty & Interest Directive, similar to the Parent-Subsidiary Directive)
    • 7: PE status
    • 13: Country-by-Country (CbC) reporting
  • Common Corp. Tax Base (absent later consolidation phase) proposal to be introduced in 2016

The EU continues its pace to maintain its global lead in addressing anti-BEPS concerns, which will impact non-EU countries around the world.  Thereby, it provides another set of rules that would be mandated to achieve EU conformity.

 

 

 

Category:

OECD

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Global mobility & BEPS risks

Global mobility will face, directly and indirectly, various challenges resulting from OECD’s BEPS proposals.  PwC’s Insights provide a concise summary of these proposals, included for reference:

Click to access pwc-oecd-final-beps-package-what-does-it-mean-for-global-mobility.pdf

Key points:

  • Treaty changes, either bilaterally or via the Multilateral Instrument, will affect key issues and risks, including permanent establishment (PE).
  • Unilateral changes, several of which have been enacted, should be reviewed with a focus on global mobility functions.
  • The transparency initiative will encourage tax authorities to aggressively pursue PE and treaty based rules.
  • What is the impact of the change for PE dependent/independent test.
  • Responsibilities of senior executives, sales representatives and regionally based employees will need to be reviewed for the new rules.
  • People functions re: controlling risk should receive separate review.
  • Intercompany agreements (i.e. legal form) should be compared to practical substance responsibilities to evidence conformity, as analyses will use legal agreements as only a first step to understand the transactions and potential consequences.

Post BEPS, it is imperative that global mobility’s function and responsibilities should be reviewed, from a tax risk awareness perspective as well as internal governance controls.  To the extent that global mobility is not closely collaborated with the tax function, the ways of working and reporting should be reviewed to address this new world of international tax transparency and the emphasis on multinationals paying their fair share of tax, however construed.

 

 

Category:

OECD

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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.

 

Category:

PE

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TFEU: Tool for EU Directives

The European Commission (EC) and European Parliament (EP), including the TAXE Committee on Rulings established by the EP, have recently endorsed many provisions that would normally require the unanimity of approval by the Member States.  Knowing this has not resulted in success with prior initiatives, a renewed focus may be taking place re: Article 116 of the Treaty on the Functioning of the European Union (TFEU) which empowers the EC/EP to issue a Directive accordingly.

Article 116 TFEU:

Where the Commission finds that a difference between the provisions laid down by law, regulation or administrative action in Member Sates  is distorting the conditions of competition in the internal market and that the resultant distortion needs to be eliminated, it shall consult the Member States concerned.

If such consultation does not result in an agreement eliminating the distortion in question, the EP and the EC, acting in accordance with the ordinary legislative procedure, shall issue the necessary directives.  Any other appropriate measures provided for in the Treaties may be adopted.

 

The TFEU is the same legal mechanism used to address State Aid, and may also be the choice of implementation to establish Directives for one or more of the following initiatives:

  • EU Common Corporate Tax Base (CCTB)
  • Country-by-Country (CbC) reporting, public disclosure
  • Tax rulings, (redacted) public disclosure
  • Permanent Establishment (PE) definition
  • Anti-BEPS Directive, transforming OECD “soft law” into an EU legislative framework
  • Interest & Royalty Directive requiring confirmation of EU tax being paid elsewhere
  • EU Dispute Resolution approach

Everyone should monitor the EC, EP and TAXE for continuing developments, as they may form the basis for new global standards to enact the intent of BEPS initiatives.

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OECD

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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.

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PE

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S. Africa: Draft notice on “reportable arrangements”

In an ever-increasing tidal wave of transparency proposals, the South African Revenue Service (SARS) issued a draft notice on Reportable Arrangements.

The proposals provides that a Reportable Arrangement must be reported to SARS with 45 business days if:

  • A nonresident renders technical, managerial or consultancy services (non-defined terms) to a resident, and
  • The nonresident, its employees, agents or representatives were or will be physically present in S. Africa in rendering such services, and
  • The expenditure will exceed R10M (approx. $823k) in the aggregate.

Penalties for non-disclosure are applicable, and SARS may use this new mechanism to determine if the non-resident company is registered for income tax or VAT in S. Africa and if there is a permanent establishment (PE) for profit attribution.

Click to access 2015G_CM5521_South%20Africa%20issues%20draft%20notice%20on%20reportable%20arrangements.pdf

This proposal is important to monitor, as it highlights different methodologies for determining what services are being provided by non-resident companies, and if such activities could be designated as a PE with some profits subject to tax.  

The UK’s Diverted Profits Tax, Australia’s follow the leader implementation in its General Anti-Avoidance Rules (GAAR) and this disclosure present different processes that tax administrations are looking to capture additional taxes for fiscal growth, incentived by the OECD BEPS Guidelines and objectives, although such Guidelines are not yet finalized.

Category:

Transfer Pricing

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US Model Income Tax Convention: A new world

The US Dept. of Treasury has released drafts of its proposed revisions to the US model income tax convention, for which it has requested comments.  The new Model treaty will serve as a template for future US treaties and protocols. A PwC summary and US Treasury press release, which further reference the proposed changes, are included for reference: http://www.pwc.com/en_US/us/tax-services/publications/insights/assets/pwc-us-treasury-proposes-changes-us-model-income-tax-convention.pdf http://www.treasury.gov/press-center/press-releases/Pages/jl10057.aspx Key observations:

  • Exempt permanent establishment (PE) rule that will also apply to US branches
  • Denial of treaty benefits re: articles 11 (Interest), 12 (Royalties), and 21 (Other income) for recipients in a “special tax regime.”  There are several exceptions applicable to the general rule.
  • Disallowance of treaty benefits for payments of dividends, interest, royalties and other income for 10 years after a company expatriates.
  • Changes to Limitation on Benefits (LOB) article: (i) New derivative benefits test which is inclusive of a base erosion test, (ii) a base erosion test to the subsidiary of a public company requirement, (iii) changes to base erosion requirements in the public company test, ownership base erosion test and derivative benefits test, and (iv) a change to the discretionary grant of relief clause inclusive of a principal purpose test.
  •  Partial termination provisions for subsequent law changes exempting, or reducing the tax rate to less than 15% for dividends, interest, royalties and other income.

These significant changes represent acknowledgment of the OECD BEPS impact and its impact on the world’s tax treaties that will directly impact the taxation of a multinational company’s global structure.  Accordingly, these changes are required reading for international tax practitioners, as the rest of the world will be following along in measuring its respective treaties and new protocols. BEPS Action 6, Preventing treaty abuse, recognized the US Model Treaty’s LOB article, with an additional inclusion for a derivative benefits test.  The US proposal has now addressed that intent.

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OECD

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BEPS Action 7: PE, Round 2

The OECD has released its second draft, following its initial draft on 31 October 2014, on BEPS Action 7: Preventing the Artificial Avoidance of PE Status.  Comments, which should be kept as short as possible, on this latest draft should be sent by 12 June 2015.  The discussion draft, and related comments, will be discussed at the Working Party 1 meeting of 22-26 June 2015.

A link to the latest discussion draft is provided for reference:

Click to access revised-discussion-draft-beps-action-7-pe-status.pdf

Key observations:

  • Objective is to address commissionnaire arrangements and fragmentation of operations to meet the “preparatory and auxiliary” exception.
  • Alternative PE options from the first draft have been reduced to 1 proposal re: each PE avoidance strategy, concluding that Option B re: commissionnaire arrangements, Option E re: specific activity exemptions and Option J re: fragmentation are the best models.
  • Follow-up work on attribution of profits issues re: Action 7 would result in additional guidance by the end of 2016, the deadline for negotiation of the multilateral instrument.
  • Low-risk distributor arrangements are to be addressed in Action 9, Risks and Capital.
  • Par. 5 alternative test: Independent agent exception is disregarded if it meets a control (50 % or more interest) test.  Persons (acting on behalf of an enterprise) habitually concluding contracts or habitually negotiating the material elements of contracts can lead to a PE, disregarding the act of formal conclusion/approval/review in another jurisdiction.  “Contracts” refers to the business proper of the enterprise.
  •   Each specific activity exemption would be restricted to activities that are otherwise of a “preparatory or auxiliary” character.  Additional Commentary guidance and examples are provided re: the phrase “preparatory or auxiliary.”
  • Re: splitting up of contracts for the 12-month threshold, the concept of “connected enterprises” replaces “associated enterprises” along with anti-abuse rules for determination.

The above captions provide only a snapshot of the detailed proposals and changes included in this latest draft; accordingly all interested parties should review this draft carefully and consider providing succinct comments for consideration in the final guidelines.

As PE is a strong pillar in the foundation of transfer pricing, this draft will chart the course for future PE determinations that may impact current organization structures and where profits from certain activities are taxed.

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OECD

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UK Diverted Profits Tax (DPT): Start your engines

Clifford Chance has provided an excellent primer discerning the objectives, framework and challenges of the UK DPT that await MNE’s with a commencement date of 1 April, 2015.  The most recent guidelines were set forth in the latest UK Finance Bill, including a narrowing of the notification requirement while expanding the permanent establishment (PE) threshold.  A link to the summary and related PDF detail, as well as recently issued guidance from HMRC, are included for reference:

http://www.cliffordchance.com/briefings/2015/03/the_uk_diverted_profitstaxfinallegislatio.html

https://www.gov.uk/government/publications/diverted-profits-tax-guidance/summary-of-amendments-following-the-technical-consultation

This new “tax” is controversial, although its tentacles have already spread to Australia and other countries for similar consideration and implementation.  Additionally, it is worth noting that the OECD is closely watching these actions, remembering the viral discussions that ensued after UK and Germany jointly endorsed the “substantial nexus” approach for intangibles.

MNE’s will need to understand this new initiative and design a course of action, starting with documentation of its actions directly / indirectly in the UK and deciding if it is beneficial, and how, to discuss such conclusions with HMRC.  Apart from potential double taxation, there are many uncertainties introduced by this legislation.

Only time will tell how aggressively HMRC will pursue this “tax,” especially with its commencement on the heels of an upcoming election for which politics and taxes are always intertwined.

Category:

OECD / UN, Transfer Pricing

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TEI comments: BEPS IP & VAT Guidelines

TEI submitted comments on the Modified Nexus Approach for IP (BEPS Action 5) and International VAT/GST Guidelines.  Links to the submissions are provided for reference:

Click to access TEI%20Comments%20-%20BEPS%20Action%205%20Harmful%20Tax%20Practices%20-%20FINAL%20to%20OECD%2019%20February%202015.pdf

Click to access OECD%20VAT%20Guidelines%20-%20B2C%20Practical%20Application%20-%20TEI%20Comments%20-%20FINAL.pdf

Summary: IP, BEPS Action 5:

  • Accelerated  comment process will likely lead to suboptimal results.
  • The singular entity approach to benefit from the IP regime is problematic from a potential restructuring necessity and poses deviations from the arm’s length principle.
  • R&D and patents have been expressly stated as benefitting from the IP regime, whereas other activities are not yet mentioned.
  • Limiting the preferential regime to strictly patents, vs. innovative software, etc., represents a myopic approach.
  • The 2021 expiration date for existing regimes seems too short-sighted for patents that may last 20 years.

Summary: International VAT/GST Guidelines

  • Unilateral implementation of such guidelines erodes the neutrality principle, leading to double taxation or double non-taxation.
  • Recommendations should align with the OECD discussions for a reverse charge mechanism in B2B scenarios.
  • Supplier based documentation requirements should be practical and simple.
  • The statement that a VAT/GST registration does not create PE should be moved from a footnote to the body of the document for clarity.
  • The lack of consistency in application of transfer pricing adjustments for VAT/GST will provide increased risk of double taxation.
  • Final rules that are clear and uniformly interpreted should be implemented via simple, consistent, flexible and proportional guidelines.

TEI’s comments for these two critical topics convey practical and thoughtful considerations for change prior to final implementation.  They should thereby be reviewed to better understand the global context and potential consequences for these actions.

 

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OECD / UN

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UK Diverted Profits Tax: Parliamentary debate

The UK Diverted Profits Tax proposal (refer to 12 December 2014 post) will become effective in April, 2015.  The Parliament debate sheds light on the intentions for such tax, as well as the assumptions (true or false) underlying this initiative.

The debate clarifies that such “tax” is not meant to be a tax that meets the definition of a tax for double tax treaty purposes, therefore it is subject to domestic legislation and not overridden by its treaty network.  This rationale therefore leads to the premise that it may not qualify as a tax subject to a US Foreign Tax Credit, resulting in a double “tax” situation regardless of the nomenclature.  Additionally, the Mutual Agreement Procedure (MAP) provided for in a double tax treaty would not be available for recourse.

The tax is aggressive in its timing, ahead of the final OECD proposals and in contrast to other initiatives for which the UK is awaiting final BEPS guidance.  The debate highlights the cynicism about the OECD process, thus providing a rationale for unilateral legislation sooner vs. later.  Additionally, this proposal was discussed as a Targeted Anti-Avoidance Rule (TAAR), which is in addition to the EU and UK General Anti-Avoidance Rules (GAAR).

Most importantly, a diverted profit tax situation involves an initial recharacterization assessment by HMRC, requiring payment by the taxpayer, with appeals to follow later – a “Pay Now, Talk Later” approach.

The clock is ticking and time is winding down with alot of questions remaining unanswered.  The debate is provided for reference:

http://www.publications.parliament.uk/pa/cm201415/cmhansrd/cm150107/halltext/150107h0001.htm

It is very useful to review the Intent of new laws to form a better understanding for the formation of such initiatives, as well as comprehension into the foresight of drafters re: possible appeals by the European Commission and/or European Court of Justice.

Category:

Transfer Pricing

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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.

Category:

OECD / UN, PE, Transfer Pricing

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Cooperative Compliance: Best Practices re: Global Mobility

Cooperative compliance is an initiative that is being used more regularly to further efforts by tax administrations for tax transparency.  (Refer to 13 June, 2013 post: OECD: A Framework for Co-operative Compliance)

The referenced PwC Tax Policy Bulletin highlights the use of this popular technique for Global Mobility compliance and Best Practices.  The Bulletin provides a primer for processes of global mobility compliance and integration of a cooperative compliance approach, including the relevant benefits and risks.

Click to access pwc-cooperative-compliance-global-mobility-tax-policy.pdf

Key observations:

  • Many countries have the potential to immediately negotiate an agreement to streamline mobile employee compliance.
  • There is an opportunity to minimize/control risks due to global talent shifts, short-term business travelers / assignees, targeted tax audits, administrative complexity, Permanent Establishment (PE) exposure, etc.
  • Tax control framework methodologies should be in place for review by tax authorities to review internal processes.
  • This initiative should be in synergy with the global / regional / country tax strategy for alignment.

This important initiative should be supported by tax expertise for the global mobility function via internal and/or external resources.  Accordingly, the impetus of tax transparency, complexity and corporate accountability may provide perfect timing to review the organizational structure of the global mobility function and inherent tax expertise provided, resulting in a Best Practice methodology as part of the global tax risk framework.

Category:

Tax Risk Management

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OECD BEPS Action 7 Guidance: PE Avoidance

OECD has released guidance on the BEPS Action Plan item 7: Preventing the Artificial Avoidance of PE Status.  Comments should be sent by 9 January 2015.  A link to the OECD guidance is attached for reference:

Click to access action-7-pe-status-public-discussion-draft.pdf

Key observations:

  • Commissionaire arrangements: 4 alternatives are provided re: PE avoidance
  • “Independent agent” activities: the independent agent must not act exclusively for one enterprise
  • Options to counter specific activity exemptions are introduced to counter artificial avoidance of PE
  • Two options are provided re: splitting up of construction contracts to avoid the 12 month rule, one of which is the Principal Purpose test general anti-abuse rule
  • Insurance agent PE proposals are introduced
  • Profit attribution concepts to PE are discussed

In summary, additional subjectivity rules are introduced while the current exemption definitions are narrowed.  These actions will tend to significantly increase tax appeals and the risk of double taxation.

All MNE’s should review the guidance to understand the trend for future PE guidance, while also identifying current structures that may be affected by the new rules.  Notably, countries may unilaterally develop legislation based upon this guidance without waiting for final guidelines to be issued, thereby introducing greater complexity and challenges in the determination of PE.

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OECD / UN

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UN Tax Workshop, including BEPS Subcommittee

The UN organized its second workshop on “Tax Base Protection for Developing Countries” on 23 Sept. 2014.  The background materials for the workshop provide valuable insights into the roles that developing countries will continue to play, directly or indirectly, as a part of the OECD BEPS Action Plan.  The final outcome of the project will be a UN handbook.  The topics for the workshop were in parallel with the background materials, focusing on the following topics: (1) Preventing the artificial avoidance of PE status; (2) Neutralizing effects of hybrid mismatch arrangements; (3) Limiting interest deductions; (4) Taxation of capital gains; (5) Preventing tax treaty abuse; and (6) Transparency and disclosure.  Additional information, including the background materials, are referenced at the following link:

http://www.un.org/esa/ffd/tax/2014TBP2

This workshop, and its continuing developments, are significant in assessing whether the OECD Actions will be followed by developing and non-OECD countries in their recommended form and/or if a simpler, more direct application of international tax rules will be pursued.  All interested parties should be aware of these materials and the forthcoming UN handbook.

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OECD / UN

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