Permanent Establishment Concept: How to Apply it to Modern Business Operations

Transcription

1 Permanent Establishment Concept: How to Apply it to Modern Business Operations OECD/USCIB/BIAC Tax Forum Recent OECD Initiatives in International Taxation: Permanent Establishment and Dispute Settlement Procedures The Cosmos Club Washington, DC January 13, 2005 WDC01/

2 OECD Work related to the Permanent Establishment Definition 2

3 OECD work on Permanent Establishments Since the mid-1990s, there have been different OECD projects related to the PE definition: OECD set up a Working Group on Permanent establishments in 1994 to deal with practical issues related to the PE definition Business asked the OECD to clarify the server-pe issue The emergence of e-commerce required the OECD to examine whether the current treaty rules, including the PE definition, were appropriate for e-commerce Business asked for clarification of some of the fundamental aspects of the PE definition following a court decision Member countries asked the OECD to consider various alternative treaty rules for the treatment of services Member countries asked the OECD to examine issues related to commissionnaire arrangements 3

4 The scope of the OECD work The interpretation of the current definition: Work of the Working Group on Permanent establishments The server-pe issue 2005 clarification of some fundamental aspects of the PE definition Part of the work on commissionnaire arrangements (and business restructuring) Should the current definition be supplemented or modified? The work of the Business Profits TAG Alternative treaty rules for the treatment of services Part of the work related to commissionnaire arrangements (and business restructuring) 4

5 2003 update First results of the work on PE: Application of the PE definition in the context of E-Commerce Permanent establishment interpretation issues 5

6 Application of the existing PE definition to e-commerce Draft released by Working Party 1 in October 1999 Comments received Revised draft released 3 March 2000 More comments received Working Party finalized discussions in September 2000; Committee adopted the changes in December 2000 Changes included in the 2003 update 6

7 What has been concluded A web site alone cannot be a permanent establishment: virtual is not real Hosting of a web site by an ISP not a PE since the server is not at the disposal of the enterprise that owns the web site PE can exist if the place where the server is located is at the disposal of the non-resident and activities performed there go beyond preparatory or auxiliary 7

8 Permanent establishment interpretation issues Results of the work of the Working Group on Permanent Establishments Background report published in May 2003 Focusses on practical issues arising from litigation or competent authority work Output: a number of changes to the Commentary on Article 5 first released in October 2001 (presented at the San Francisco IFA Congress) and finalized at the end of

9 The basic PE definition Article 5(1) A fixed place of business through which the business of an enterprise is wholly or partly carried on place place of business fixed place of business through which business is carried on 9

10 Place must be a place of business must be fixed Is a country a place? Is a city a place? Is a road or a forest a place? Is an office in a building a place? 10

11 Fixed Geographical aspect (new paragraphs 5.1 to 5.4) Fixed place Temporal aspect (new paragraphs 6 to 6.2) Administrative guideline to solve dispute: If more than 6 months, PE If less than 6 months, no PE Exception for recurrent activities and activities carried on only in one country 11

12 through which the business of an enterprise is wholly or partly carried on Most difficult part of the definition: relationship between place and taxpayer s business (new paragraphs 4 to 4.6) owned or rented by the taxpayer? legal right? right to use or simply use? when is a place at the taxpayer s disposal? use of client s or subsidiary s place of business? construction site for a subcontractor? construction site for a main contractor? 12

13 Construction Sites Article 5(3) construction site is PE only if it lasts more than 12 months deeming rule or additional condition? [next slide] treatment of subcontractors general contractor or architect with on-site office? multiple projects? temporary disruptions? 13

14 What is paragraph 5(3)? Paragraph 5(3): A building site or construction or installation project constitutes a permanent establishment only if it lasts more than twelve months. Is this A deeming rule (deeming a PE to exist when it would not) An exception to paragraph 5(1)? 14

15 The practical consequences If it is a deeming rule, there is no need to identify a particular location as long as there is an installation project (e.g. a 13-month contract to install equipment in all the German branches of a German bank) If it is only an exception, the Commentary examples of a construction site PE (e.g. paragraphs of the Commentary) illustrates the scope of paragraph 5(1) 15

16 The history of 5(3) In the 1963 Draft convention, the rule was included in paragraph 5(2): 2. The term permanent establishment includes especially: [ ] g) a building site or construction or assembly project which exists for more than twelve months. Paragraph 5(2) is merely illustrative of paragraph 5(1): such places of business constitute permanent establishments only if they meet the requirements of paragraph 1 (paragraph 12 of the Commentary) 16

17 Why the change in 1977? It was suggested that the rule, as drafted in the 1963 Draft Convention, simply did not deal with construction sites lasting less than 12 months, which could therefore be considered to be permanent establishments under paragraph 5(1) 17

18 The UN Model Paragraph 5(3) 3. The term permanent establishment also encompasses: a. A building site, a construction, assembly or installation project or supervisory activities in connection therewith, but only if such site, project or activities last more than six months; b. The furnishing of services This is clearly a deeming rule and the last part is a condition for the rule to apply 18

19 Preparatory Activities Article 5(4) Little substantial clarification of the preparatory or auxiliary activities exception in the 2003 report use of or in paragraph 25 new paragraph 27.1 on places separated organisationally for the purposes of 4 f) Background report also deals with a case of split-up of storage facilities See also the BP TAG report 19

20 Agency PEs Article 5(5) agent deemed to be PE of nonresident if agent acts on behalf of nonresident and habitually exercises authority to conclude contracts not applicable to agents of independent status not applicable if agent s activities are limited to preparatory activities 20

21 Dependent Agents - Policy Rationale the fixed place of business rule alone would enable an enterprise to carry on significant economic activity, indirectly through another person, without triggering a taxable presence thus an additional rule is required which ensures that where an enterprise participates significantly in the economic life of a state through an agent a permanent establishment will be deemed to exist 21

22 Agency PEs 2003 clarification dealing with agency permanent establishment: agent needs not be a resident or have a place of business (amended paragraph 32) has and habitually exercises an authority to conclude contracts (new paragraphs 33.1 and 38.1) factors indicating independence (new paragraphs 38.2 to 38.7) when are agents acting outside the ordinary course of their business? (new paragraph 38.8) 22

23 2005 clarification As a result of a court decision, Working Party No. 1 was invited by business to expressly confirm in the Commentary some widely-accepted interpretations related to the permanent establishment concept Discussion draft released on 12 April 2004 Slightly amended in September 2004 Will be included in the 2005 update (no other PE changes in the 2005 update) 23

24 Clarification in the 2005 update 3 issues to be clarified PE determination must be made for each company of a group Providing management services to another company of the group does not mean that the company has a PE Participation in meetings is not enough to conclude that one exercises an authority to conclude contracts 24

25 2005 clarification 41.1 [ ]The determination of the existence of a permanent establishment under the rules of paragraphs 1 or 5 of the Article must, however, be done separately for each company of the group. Thus, the existence in one State of a permanent establishment of one company of the group will not have any relevance as to whether another company of the group has itself a permanent establishment in that State. 25

26 2005 clarification 42. Whilst premises belonging to a company that is a member of a multinational group can be put at the disposal of another company of the group and may, subject to the other conditions of Article 5, constitute a permanent establishment of that other company if the business of that other company is carried on through that place, it is important to distinguish that case from the frequent situation where a company that is a member of a multinational group provides services (e.g. management services) to another company of the group as part of its own business carried on in premises that are not those of that other company and using its own personnel. In that case, the place where those services are provided is not at the disposal of the latter company and it is not the business of that company that is carried on through that place. That place cannot, therefore, be considered to be a permanent establishment of the company to which the services are provided 26

27 and (added in September) Indeed, the fact that a company s own activities at a given location may provide an economic benefit to the business of another company does not mean that the latter company carries on its business through that location: clearly, a company that merely purchases parts produced or services supplied by another company in a different country would not have a permanent establishment because of that, even though it may benefit from the manufacturing of these parts or the supplying of these services. 27

28 2005 clarification 33. [ ] situation. A person who is authorised to negotiate all elements and details of a contract in a way binding on the enterprise can be said to exercise this authority "in that State", even if the contract is signed by another person in the State in which the enterprise is situated or if the first person has not formally been given a power of representation. The mere fact, however, that a person has attended or even participated in negotiations in a State between an enterprise and a client will not be sufficient, by itself, to conclude that the person has exercised in that State an authority to conclude contracts in the name of the enterprise. The fact that a person has attended or even participated in such negotiations could, however, be a relevant factor in determining the exact functions performed by that person on behalf of the enterprise. Since [ ] 28

29 Are the Current Treaty Rules for Taxing Business Profits Appropriate for E-commerce? Report completed by the TAG in April 2004 Report presented to the CFA in June 2004 The BP TAG has now completed its mandate 29

30 Table of contents of the Report 1. Introduction 2. Description of the current treaty rules for taxing business profits 3. A critical evaluation of the current treaty rules with respect to e-commerce 4. Some alternatives to the current treaty rules for taxing business profits A. Changes that would not require a fundamental modification of the existing rules B. Changes that would require a fundamental modification of the existing rules 5. Conclusions 30

31 The alternatives that were examined A. Changes that would not require a fundamental modification of the existing rules Modification of the permanent establishment definition to exclude activities that do not involve human intervention by dependent agents Modification of the permanent establishment definition to provide that a server cannot, in itself, constitute a permanent establishment Modification of the permanent establishment definition/interpretation to exclude functions attributable to software when applying the preparatory or auxiliary exception 31

32 The alternatives that were examined Elimination of the existing exceptions in paragraph 4 of Article 5 or making these exceptions subject to the overall condition that they be preparatory or auxiliary Elimination of the exceptions for storage, display or delivery in paragraph 4 of Article 5 Modification of the existing rules to add a force-ofattraction rule dealing with e-commerce Adopting supplementary nexus rules for purposes of taxing profits arising from the provision of services 32

33 The alternatives that were examined B. Changes that would require a fundamental modification of the existing rules Adopting rules similar to those concerning taxation of passive income to allow source taxation of payments related to some forms of e-commerce A new nexus: base eroding payments arising in a country Replacing separate entity accounting and arm s length by formulary apportionment of profits of a common group Adding a new nexus of electronic (virtual) permanent establishment 33

34 Conclusions of the Report Alternatives for fundamental changes: not appropriate to embark on such changes at this point in time BUT need to continue to monitor the effect of the new business models on tax revenues existing international rules for taxing business profits have some shortcomings some of which could be addressed through changes based on some of the more restricted alternatives 34

35 Current work related to the permanent establishment definition Working Party no. 1 is also carrying on other work related to the permanent establishment definition which could result in further changes in a subsequent update: the application of tax treaties to services; work on corporate restructuring, which includes the examination of commissionaire arrangements; subcontractor who subcontracts all aspects of a construction contract (while that change was included in the first draft of the 2003 update that was released in October 2001, it was pulled out at the request of one country that wanted to have it reconsidered); another proposal that was pulled out of the 2003 update following comments received from business representatives, was to add a new paragraph 38.7 on the assumption of entrepreneurial risk as a distinguishing feature of the independent agent (that proposal will be reviewed as part of the work on corporate restructuring). 35

36 Case 1 - Consulting Services Scenario 1 Consulting is headquartered in Country X. It has wholly-owned subsidiaries located in a number of countries around the world including SubA, SubB, SubC located respectively in Countries A, B, and C. Consulting enters into a contract with Customer, which is also headquartered in Country X, to provide consulting services related to the installation of a new customer relationship management (CRM) system. The contract indicates that in addition to services provided in Country X, consulting will provide services to customer affiliates in Countries A, B and C either itself or by contracting the work to Consulting s subsidiaries in these countries. Consulting chooses to subcontract the non-country X work to its subsidiaries and pays its subsidiaries an arm s length fee based on the cost plus method. The project takes a total of 12 months. Does Consulting have PEs in countries A, B, and/or C? 36

37 Case 1 - Consulting Services Scenario 2 Same as scenario 1, except that the nature of the project requires that Consulting send its owns employees to Countries A, B, and C. Consulting s employees will be working at the premises of Customer and will not normally use the premises of Consulting affiliates. The employees will remain on the job at Customer premises for the duration of the project --12 months -- but may travel for personal reasons back to Country X periodically. Customer controls access to its premises and requests that Consulting employees work under direction of Customer employees. Does Consulting have a PE in countries A, B, or C? 37

38 Case 1 - Consulting Services Scenario 3 Same as scenario 2, except that: Scenario 3a: Consulting s employees are provided badges by Customer that allow 7 by 24 access to Customer facilities Scenario 3b: Consulting s employees stay on the job for more than 12 months Does Consulting have a PE in Countries A, B, and/or C? 38

39 Case 1- Consulting Services Scenario 4 Consulting engages in a huge contract and engages the services of unrelated Subconsulting for its special expertise. Employees of both Consulting and Subconsulting work at the premises of Customer for more than 12 months under conditions similar to Scenario 3a Does consulting have a PE in countries A, B, and/or C? Does Subconsulting? Would the answers change if Subconsulting is a wholly owned subsidiary of Consulting? 39

40 Case 2 - Facts C is a UK corporation and the parent of a multinational group of affiliated corporations. FP is an unrelated US corporation and the parent of a multinational group of affiliated corporations. C and its subsidiaries manufacture various components that are incorporated into the finished products that FP and its subsidiaries manufacture. C has a US subsidiary ( C-US ) that employs engineers and salesmen to negotiate specifications for, and market, C components to FP. The actual components that the C group sells to the FP group are manufactured by C s subsidiary in China ( C-China ) and sold to FP s subsidiary in China ( FP-China ). C and C-China do not engage in any business activity in the US. 40

41 Case 2 C UK US C-US specifications FP US China C-China components payment FP-China 41

42 Case 2 - Questions 1. Do the activities of C-US cause C or C-China to have a dependent agent in the US? 2. If C-US were otherwise a buy-sell distributor or manufacturer, would negotiating for its affiliates be treated as not in the ordinary course of its business? 3. If C-US were not engaged in any other business, could it bear sufficient entrepreneurial risk to be economically and legally independent of its affiliates? 4. If C-US does not actually sign contracts with FP, could C-US nevertheless be deemed to be habitually concluding contracts on behalf of C or C-China? 5. Would the answer be different if C-US can calculate the price per good by formulas set by C and then finalize the terms of sale from C-China to FP-China? 6. Is C-US providing services as part of its own business carried on in premises that are not those of C or C-China? 7. If C were to send its own employees to the US instead of relying on employees of C-US, would the result be different? 42

43 Case 3 - Facts X group is a multinational group that manufactures and sells products around the world under the X brand. P is the parent of the X group and the owner of the world-wide rights to the X brand. S is a subsidiary of P. P is organized and operates solely in Country A, and S is organized and operates solely in Country B. S manufactures and sells products in Country B under the X brand. In response to certain quality control issues, S has asked P to send some P employees to oversee its operations. In addition, P has determined that quality control issues at S are adversely affecting the X brand. S provides these P employees with an office from which to work. S will compensate P for the salaries of the P employees. The P employees are expected to remain at S for a period of six months. 43

44 Case 3 P Country A employees Country B S 44

45 Case 3 - Questions 1. Does P have a fixed place of business in country B (i.e., are S s premises at the disposal of P)? 2. Would the answer be different if S did not provide P s employees with an office? 3. Would the answer be different if the activities of P s employees are limited to those that S has requested? 4. Is the business of P being carried on at the premises of S? 5. Would the answer be different if P initiated the assignment of its employees to protect the X name, rather than S requesting the assignment of the employees? 6. Would the answer be different if P seconded the employees? 7. Would the answer be different if S had multiple facilities and P s employees spent only a limited amount of time at each facility? 8. Would the answer depend on the amount of time that the employees of S were at P s facility? 45

46 Case 4 - Electronic Software Distribution Scenario 1 US software developer (USCO) develops and distributes standard software electronically via internet download Local subsidiary (LOCO) is established in Country X and performs advertising services in Country X for USCO for a fee. Customers are in Country X Software is downloaded from a server located in the US A separate server also located in the US maintains the order management and transaction software Does USCO have a PE in Country X? 46

47 Case 4 - Electronic Software Distribution Scenario 2 Same as scenario 1, except that the download server(s) is located in Country X. Subcase 1: USCO rents download servers from unrelated data farm co (located in Country X) that owns and maintains the servers and the facility in which they are located (in Country X) and charges USCO a fee Subcase 2: Same as subcase 1, except the server lease agreement is between LOCO and unrelated co. Does USCO have a PE in Country X? In Subcase 1? In Subcase 2? 47

48 Case 4 - Electronic Software Distribution Scenario 3 Same as scenario 2, except both the download server and the transaction server are located in Country X. USCO provides the software and programming to unrelated co (in Country X) that in turn loads the software onto its own servers (in Country X) and provides the hosting service. USCO has the hosting contract with unrelated co. Does USCO have a PE in Country X? 48

49 Case 4 - Electronic Software Distribution Scenario 4 Same as scenario 3, except that USCO rents the servers from unrelated co (as opposed to using a hosting service). Does USCO have a PE in Country X? 49

50 Case 4 - Electronic Software Distribution Scenario 5 Same as scenario 3, except that the servers are owned and maintained by LOCO (in Country X), which provides a hosting service to USCO. USCO pays LOCO a fee to cover its costs plus provide LOCO with a profit similar to that earned by unrelated co in scenario 3. Does USCO have a PE in Country X? 50

51 Case 4 - Electronic Software Distribution Scenario 6 Same as scenario 5 except that USCO owns or rents the servers located on the premises of LOCO (in Country X) and pays LOCO a fee to maintain them and to follow specific instructions as to how the server usage is performed. Does USCO have a PE in Country X? 51

52 Case 4 - Electronic Software Distribution Scenario 7 Same as scenario 6, except that LOCO also has a staff responsible for pricing decisions in Country X and determines pricing policy and uploads the pricing information onto the servers that USCO owns or leases in Country X. Does USCO have a PE in Country X? Could USCO have 2 PEs from both the servers and the activities of LOCO? 52

53 Case 5 - Facts The Olympiad is held for three weeks in Country X. Rental Co. leases certain equipment to LOC (the local Olympics organizing committee) to be used at the Olympiad. Charitable Co. donates the use of certain equipment to LOC to be used at the Olympiad in exchange for recognition as a sponsor. Broadcast Co. brings certain equipment and personnel into Country X to broadcast events at the Olympiad to viewers in Country Y. Broadcast Co. sells advertising that is to be included in the broadcast of the Olympiad. LOC contracts with Security Co. to send employees to review the security arrangements and advise on deficiencies. Each of Rental Co., Charitable Co., Broadcast Co. and Security Co. is organized in Country Y and conducts no business in country X except as described herein. 53

54 Case 5 - Questions 1. Does the Olympiad constitute a place of business for Rental Co., Charitable Co., Broadcast Co., or Security Co.? 2. Would the conclusion with respect to Security Co. be different if Security Co. had employees on the ground providing security services during the Olympiad? 3. If so, does that place of business have the requisite degree of permanency with respect to the business of Rental Co., Charitable Co., Broadcast Co., or Security Co. have a PE in Country X? 4. Would the conclusion with respect to the place of business of Rental Co., Broadcast Co., or Security Co. be different if each of these enterprises were created solely for the duration of the Olympiad and solely to perform functions with respect to the Olympiad? 54

55 Case 6 - Facts I is a citizen of Country X and the president of P. I is also the president of S, a subsidiary of P. P is organized as a Country X corporation and conducts business solely in Country X; S is organized as a Country Y corporation and conducts business solely in Country Y. I visits S for two weeks each year; otherwise, I participates in the management of S from his office at P. S directly compensates I for the services that I renders to S. S sells product that it purchases from P. 55

56 Case 6 - Questions 1. Does S have a place of business (e.g., a place of management) in country X? 2. Would the answer be different if I were not an employee of P but instead maintained an office in his home and worked from that home office? 3. Would the answer be different if S paid P for I s services, such that P provides services to S with its own personnel as part of its own business carried on in premises that are not those of S? 4. Would the answer be different if S s Board were to adopt a resolution that explicitly prohibited I from signing any contracts while in country X? 56

57 Case 6 P ( I ) Country X Country Y S 57