Strategizing International Tax Best Practices – by Keith Brockman

Posts tagged ‘permanent establishment’

UN: TP Manual for Developing Countries

The UN has published the second edition (First edition in 2013) of a transfer pricing manual for developing countries.

The world has changed considerably since 2013, notably affected by BEPS and the OECD’s  actions, including collaborating with developing countries.  However, the UN notes developing countries may not have the sophistication as other developed countries, and this manual provides valuable insight into the trends in this area.

The transfer pricing practices of Mexico, China and Brazil are also summarized in this edition.

The TP Manual is a “must read” for international tax practitioners to fully understand today’s complex dynamics that do not lead to global consistency or simplification.

http://mnetax.com/wp-content/uploads/2017/04/UN-2017-Manual-TP.pdf

 

PE & Global Mobility partner

As the subject of permanent establishment (PE) becomes more controversial amid the ever-changing rules, multinationals (MNEs) should have a proactive partnership relationship with their global mobility service provider, whether in-sourced or outsourced.

Global mobility generally reports through the HR function, thus a silo approach may result without the proactive ability of the tax function to create a cohesive team.  The concepts of legal employer, economic employer, intercompany allocations, foreign reporting relationships, contractual arrangements, intercompany agreements, etc. all need to be vetted and challenged for every assignment that may have adverse consequences for the employee and/or the company.

Countries are taking a more aggressive PE approach, thus a standard assignment template and / or agreement may not work in today’s post-BEPS world.  India, for example, has very specific rules that dictate a PE without special attention to the control and payment arrangements of the assignment.  Assessments may take years to resolve requiring additional cost and time, including the necessity of external advisors.

The organizational structure of significant functions that may cause consequences for a MNE’s tax organization should be reviewed, possibly adding dotted line relationships for global mobility, customs, external communications, etc.  At the very least, these related functions should be discussing these potential issues on a regular basis, while forming a mini-university for learning.  

As the subject suggests, the organizational structure and reporting relationships should not follow the same-as-last-year approach due to the BEPS evolution around the world.  

 

 

EU Anti-Tax Avoidance Package: PPT

The EU Anti-Tax Avoidance Package included a Commission recommendation on the implementation of measures against tax treaty abuse.  Specifically, this statement was issued to address artificial avoidance of permanent establishment status as stated in BEPS Action 7 Action Plan.

Re: tax treaties of Member States that include a “principal purpose test” (PPT) based general anti-avoidance rule, the following modification is encouraged to be inserted:

“Notwithstanding the other provisions of this Convention, a benefit under this Convention shall not be granted in respect of an item of income or capita l if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that it reflects a genuine economic activity or that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of this Convention.”

This subjective phrase, that applies notwithstanding other provisions of the Convention, has already been used in new treaties and will proliferate as new treaties are drafted by a Member State, not necessarily with another Member State.  Thereby, it is important to draft supporting documentation that will provide support for transactions against which it is aimed.  This phrase will elicit additional appeals and court cases as to its meaning and / or intent for which non-consistent answers will be provided.

Questions that may be asked re: this statement:

  • Who is concluding on the reasonableness?  What facts are used for such determination?
  • Which facts and circumstances are relevant?
  • What are all of the principal purposes of the arrangement or transaction?
  • How is a benefit measured, directly or indirectly?
  • What is a genuine, vs. non-genuine, economic activity?
  • How do you determine if such arrangement is in accordance with the object and purpose of the “relevant provisions” of the Convention?

The phrase is purposefully vague, and thereby subject to inconsistent interpretation.

It is hopeful that tax administrations will use this statement wisely to address egregious transactions rather than ordinary business transactions for which the clear intent was not an evasion of tax.  This subjectivity will be important to monitor going forward to further understand subjective enforcement interpretations around the world.  

 

 

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.

http://www.ey.com/Publication/vwLUAssets/South_Africa_issues_draft_notice_on_reportable_arrangements/$FILE/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.

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.

http://tei.org/Documents/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.

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.

http://www.pwc.com/en_GX/gx/tax/newsletters/tax-policy-bulletin/assets/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.

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.

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