Your Taxes: OECD – Permanent establishment or persistent nuisance (more)?

Your Taxes: OECD – Permanent establishment or persistent nuisance (more)?

Leon Harris
The OECD is at the forefront of an international campaign to try and collect more taxes from multinational groups. Israel joined the OECD in 2010.
On May 15 the OECD published a revised discussion draft on preventing the artificial avoidance of PE (permanent establishment) status as “action” 7 of its Action Plan on Base Erosion and Profit Shifting (BEPS). This narrowed down some of the options discussed in an earlier draft of October 31, 2014.
The public is invited to comment on the revised draft by June 12. A version of this article will, therefore, be submitted to the OECD.
Background
A PE is essentially a fixed place of business or a dependent agent. For example, according to the US-Israel tax treaty, if an Israeli company is deemed to have a PE in the United States, the Israeli company must pay US tax on profits attributable to the PE and then credit the US tax against Israeli tax.
Multinational groups don’t like unintended PE’s because they result in bureaucracy and can trigger multiple taxation. But the OECD is worried that multinationals, especially digital enterprises, may be shifting profits offshore by avoiding PE’s too well.
Therefore, the draft report targets a number of “coordinated strategies” for avoiding a PE, especially via the internet, where profits “go untaxed anywhere”.
In practice, these OECD proposals may be bad for bona fide Israeli exporters.
Sales agents and commissionaires
The OECD thinks commissionaires are abusive. A commissionaire structure may be loosely defined as an arrangement though which a commissionaire sells goods in its own name but on behalf of a foreign enterprise that owns them. The commissionaire only pays tax on its own service income, not the profit from the sales.
Therefore, the draft report proposes to deem a foreign enterprise to have a taxable PE in a country regarding its sales to that country if:
·It has a person in that country acting on its behalf;
·who habitually concludes contracts on its behalf;
·or negotiates the material elements of contracts;
·in the name of the foreign enterprise, or;
·for the transfer of ownership or use of property owned by that foreign enterprise, or;
·or provision of services by the foreign enterprise.
This may seem technical but it could trigger huge foreign tax and reporting for Israeli (and other) exporters whenever they use local sales agents abroad to make sales on their behalf. This is because sales agents usually operate in the way described above.
Until now, a way out was to say no PE would arise if the local selling agent acted independently of the exporter. But the draft report says a PE will automatically arise if the agent is “connected”. That would apply if there is 50% control (voting and value) of one over the other or they are under common control.
The term “negotiates the material elements of contracts” is clarified in draft commentary of the OECD. It would typically include the determination of the parties between to the contract as well as the price, nature and quantity of the goods or services to which the contract applies. The OECD says this would be the case even if negotiation is limited to convincing a customer to accept standard terms.
Other Specific PE proposals:
The draft report proposes to clarify that certain PE exceptions will only apply if they are “preparatory or auxiliary”. For example, this may apply to:
·A warehouse in a country used by a foreign enterprise solely for storage, display or delivery of its goods or processing by another enterprise;
·A fixed place of business solely for purchasing goods or collecting information.
Preparatory or auxiliary means remote from the actual realization of profit. The decisive criterion is whether the activity forms an essential and significant part of the activity of the enterprise as a whole.
It seems that ecommerce operations need warehouses and/or collect user information which may now trigger a taxable local PE for cyberspace operators.
To counter the splitting of activities of a “cohesive business operation” among connected enterprises in a country, an anti-fragmentation rule is proposed.
Examples of a PE in the draft report include: repair of machinery, pipeline for shipping someone else’s oil and purchasing offices used to inspect the type/quality of products.
Also caught is toll manufacturing if the foreign enterprise has unlimited access to inspect and maintain goods stored there. This may affect production outsourced to China, India, Singapore, etc.
Of particular interest to Israel is the following: Where an investment fund sets up an office in a State solely to collect information on possible investment opportunities in that State, the collection of information will be a preparatory activity and the office will therefore be deemed not to be a PE.
Also of interest to Israel is scientific research. A research plant would be a PE if it not only supplies scientific information, but also furnishes plans specially developed for the purposes of the individual customer or “concerns itself” with manufacture. So a chip R&D plant is a PE….
How Much Will Get Taxed?
If a PE exists, how much taxable profit should be attributed to them? This is complex a transfer pricing issue which the OECD draft report postpones till after September 2015, with guidance expected before the end of 2016.
Comments:
The proposals relating to preparatory or auxiliary activities are understandable and may indeed increase tax revenues in a reasonable way. Nevertheless, we await the OECD’s proposals on how much taxable profit to attribute to a PE.
However, the proposals relating to commissionaires and agents represent severe overkill and should be dropped. They will hamper Israeli exporters.
Here’s why:
First, the OECD draft report apparently has a significant drafting error. It says it wants to target commissionaires who sell products in their own name (paragraph 9) but in fact targets agents who sell products or services in the name of the foreign enterprise or owned by the foreign enterprise (paragraph 23).
The OECD proposal attacks almost every sales agent in the world.
It is like taking a sledgehammer to crack the wrong nut!
Second, the proposal does not exclude bona fide operations by exporters via local agents.
Third, much international trade is via connected persons or companies who know the exporters’ product but are part of the local culture. Now, connected and unconnected agents will be a PE risk no matter how fairly they operate. This will impede international trade.
Fourth, the attack on local negotiations seems unreasonable. Will customers have to fly into the exporter’s home country to negotiate? Will emails have to be monitored to ensure this?
Fifth, little extra tax is likely to ensue. Exporters will merely switch from using sales agents to selling their goods to distributors, including low-risk distributors.
The OECD is apparentlyaware of this (paragraph 32.12).
Sixth, the OECD itself may be opposed to such proposals. In May 2014, the OECD published a new “Services Trade Restrictivesness Index (STRI)” (http://www.oecd.org/trade/services-trade-restrictiveness-index.htm). This measures restrictions on foreign entry and barriers to competition in different countries. The OECD should calculate the impact of its BEPS 6 proposals against sales agents on its own STRI index
Seventh, there will be other issues. For example, if a standard agreement is drafted by in a parent corporation in Country A and used by subsidiary corporations in Countries B to Z, will those subsidiaries in Countries B to Z each have a PE in country A?
In short, the OECD’s proposals, if adopted could change the face of international trade by wiping out sales agents.
The writer is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.
 
As always, consult experienced tax advisors in each country at an early stage in specific cases.
leon@hcat.co
June 10, 2015

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