Profit Shifting
Practitioner Predicts BEPS Work
on PEs Will Expand Beyond Action
7 Parameters
By: Kevin A. Bell
The scope of the work on permanent establishments set forth in the Organization for
Economic Cooperation and Development's action plan to combat base erosion and profit
shifting (BEPS) is likely to expand, according to a Washington, D.C, practitioner.
Steve Nauheim of PricewaterhouseCoopers LLP said Oct. 8 that the work of Action 7 of
the BEPS plan, which calls for changes to Article 5 of the OECD Model Tax Treaty, is
likely to be expanded beyond commissionaires.
Action 7 tasks the OECD with deciding whether to treat commissionaires as dependent
agents that bind their principals, a treatment that creates a PE of the principal in the
jurisdiction where the commissionaire operates.
Speaking on his firm's webcast, Nauheim said the work under Action 7 probably will be
expanded beyond commissionaires to include limited-risk distributors that are involved in
back-to-back sales transactions where the distributor simultaneously buys from the
parent company and sells to others.
Richard Collier of PwC in London said that based on the tenor of the OECD's Oct. 1
consultation on the BEPS project, it is clear that the Action 7 PE work will extend to
back-to-back sales, and also to the “fixed place of business” test and dependent agent
rules under Article 5.
However, Collier said, some countries are nervous about expanding source state taxing
rights.
Action 7 of the BEPS Action Plan tasks the OECD with changing the Article 5 PE
definition “to prevent the artificial avoidance of PE status through the use of
commissionaire arrangements and the specific activity exemptions” (145 ITM, 7/24/13).
Commissionaire Arrangements.
According to Action 7, in many countries, the interpretation of the treaty rules on agency
PE allows contracts for the sale of goods belonging to a foreign enterprise to be
negotiated and concluded in a country by the sales force of a local subsidiary of that
foreign enterprise, without the profits from these sales being taxable to the same extent
they would be if the sales were made by a distributor.
In many cases, the OECD said, this has led enterprises to replace arrangements under
which the local subsidiary traditionally acted as a distributor with commissionaire
arrangements, resulting in a movement of profits out of the country where the sales take
place without a substantive change in the functions performed in that country.
Fragmentation of Operations.
Action 7 also says that the current PE rules permit multinationals to artificially fragment
their operations among multiple group entities in order to qualify for the exceptions to PE
status for preparatory and auxiliary activities.
Nauheim said he was initially perplexed by Action 7's discussion of fragmentation
because he is unaware of taxpayers that are actively fragmenting their activities in order
to stay within the exceptions to PE status.
Although it is unclear what type of case Action 7 is aimed at, Nauheim said the OECD
may be concerned about a situation where although the PE rules treat the local agent as
an independent agent there is an additional presence. Thus, the OECD will be looking
into the nature of auxiliary activities.
Profit Attribution.
Action 7 also states that the BEPS project will address “profit attribution issues” related
to PEs.
If a company has a PE in the host country, Article 7 of the OECD Model Tax Treaty
governs which profits should be attributed to the PE. Under the authorized OECD
approach (AOA), the two steps required for attributing profits to a PE are:
• first, determine the activities and conditions of the PE based on a functional and factual
analysis, including the attribution of assets, risks and free capital as well as the
identification of dealings to be recognized between the PE and the home office; and
• second, determine the profits of the PE based on a comparability analysis and
application of transfer pricing methods premised on the allocation of risks, assets and
other attributes undertaken in the first step.
Nauheim raised the question of whether it matters if the taxpayer is deemed to have
created a PE. Would there be a significant difference in the taxable profit left in the
hands of a parent company under an AOA analysis compared to an Article 9 transfer
pricing analysis that rewards functions, assets and risks? he asked.
Collier, however, said often a significant difference in profit would result from the two
approaches.
The BEPS Action Plan calls for changes to Article 5 of the OECD Model Tax Treaty by
September 2015.
This article originally appeared in BNA’s International Tax Monitor.