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 October 31, 2014, the OECD published a 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) and the public are invited to comment by January 9, 2015. A version of this article will, therefore, be submitted to the OECD.
These OECD proposals may be bad for Israeli and other exporters.
The OECD action plan, published in July 2013, identifies 15 actions to address BEPS, and sets deadlines to implement these actions. The OECD’s recommendations are not binding, but they do show parliaments and tax authorities what measures to consider adopting in their own country. If enough countries do so, large and small MNCs will need to adapt their tax strategies.
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 of America, the Israeli company must pay US tax on profits attributable to the PE and then credit the US tax against Israeli tax. This is bureaucratic and the Israeli company will usually end up paying tax at the higher of the tax rates prevailing in the two countries.
However, it seems MNCs and digital enterprises have been exploiting legitimate loopholes in the detailed PE criteria found in tax treaties and the OECD’s model tax treaty commentary. The internet has made it easier for MNC’s to sell to clients in a country by remote control. So the OECD is now planning to tighten up the recommended PE criteria where “cross border income would otherwise go untaxed or would be taxed at very low rates” This is in order to “prevent abuses”.
The first PE loophole targeted by the OECD relates commissionaire structures. A commissionaire sells products in its own name but on behalf of a foreign enterprise that is the owner of the products. Through such an arrangement, a foreign enterprise may sell its products in a State without having a PE. Therefore the Discussion Draft offers four alternatives targetting commissionaire and similar strategies. Each alternative relates to contracts being concluded or merely negotiated by the commissionaire for the foreign company.
The second PE loophole targeted by the OECD relates to local facilities used for storage or delivery of imported goods or merchandise, or the purchase of goods or collection of information by one or more associated enterprises. The Discussion Draft offers several alternatives aimed at deeming a PE to exist unless storage and delivery activities are “preparatory or auxiliary”. Another alternative would deem any purchasing office to be a PE.
Thirdly, there are proposals aimed at certain insurance companies.
- The Discussion Draft language has too much jargon and is aimed at tax professionals, not business persons.
- The techniques referred to are usually not “abuses”. It has been accepted practice for many decades to distinguish between doing business WITH a country (usually not taxable there) and doing business IN a country (usually taxable there).
- Small and medium exporters with limited resources cannot afford to have a PE in every country where they have customers. There should be a de minimis exception for small and medium size enterprises.
- Companies do not relish registering for tax in every country they have customers serviced by commissionaires or using warehouses, as this creates an administrative burden best avoided by being efficient. The Discussion Draft does not offer an efficiency exception.
- The Discussion Draft is too widely drafted. It probably meant to take aim only at low-taxed offshore-based enterprises, but doesn’t actually do this. Companies based in onshore medium-high countries also appear to be targeted.
- We strongly object to all four of the commissionaire proposals as they will apparently catch many normal situations in which an agent or dealer sells goods for exporters. This could dramatically reduce international trade. It is generally accepted that international trade increases international prosperity, so a reduction in international trade is undesirable and unacceptable. These proposals should be scrapped.
- We object to the proposals targeting storage or delivery or purchasing or collection of information. In practice the “auxiliary or preparatory” criterion is notoriously vague. The taxation of purchasing offices will deter some international trade as they are typically used to find useful products and check they are manufactured well. The taxation of information collection will affect, among others, news bureaus and may be used as a back-door means of censorship. Instead we recommend deeming a point of sale to be a PE – this seems far fairer.
- We also suggest implementing a one-stop global PE registration authority similar to the one-stop VAT registrations allowed in a single EU country. Registration and reporting should be simplified, and only necessary once very clear PE threshold criteria have been crossed by offshore-based enterprises. Onshore enterprises should be automatically exempted from the new OECD PE proposals. Small and medium sized enterprises should also be exempted from the new PE proposals.
To conclude, it remains to be seen whether and how countries around the world apply the OECD recommendations. Exporters should review what action will be needed.
As always, consult experienced tax advisors in each country at an early stage in specific cases.
The writer is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.