BEPS Action 7: preventing the artificial avoidance of permanent establishment status.

• Author: Alajbegu, Jim
• Position: Base erosion and profit-shifting

The Organisation for Economic Cooperation and Development's (OECD's) base erosion and profit-shifting (BEPS) project, launched in 2013 in conjunction with the Group of Twenty (G-20), an international forum of the governments and central bank governors from 20 major economies, is intended to combat aggressive tax planning strategies that have the effect of shifting profits from high-tax jurisdictions to low-tax jurisdictions. The BEPS project itself has been divided into 15 proposals, or "actions." Without a doubt, one of the most far-reaching of these actions in terms of the number of companies that would be affected (regardless of size) is Action 7, Preventing the Artificial Avoidance of Permanent Establishment Status.

The stated purpose of Action 7 is to attack certain "artificial" arrangements nonresident enterprises have entered into to avoid having a taxable presence, or permanent establishment (PE), in a country, such that the taxable profits from operations in that country will be subject to tax only in the home country of the nonresident (presumably at a lower rate) under the "Business Profits" article of the relevant income tax treaty. In proposing changes to the definition of a PE in the OECD Model Tax Treaty, Action 7 focuses on perceived avoidance of PE status using agency or similar (e.g., sales commissionaire) arrangements or relying on specific exemptions from the definition of a PE, particularly those relating to "preparatory and auxiliary" activities.

Under the current OECD model language, two circumstances in which a PE will be established in a country are (1) where a nonresident company has a fixed place of business in that country; or (2) where the nonresident company has a dependent agent concluding contracts on its behalf in that country. Profits attributable to a PE are generally taxable in the country in which that PE is located.

Under the current OECD model, an agent in a country acting on behalf of an enterprise will create a PE in that country if the agent "habitually exercises authority to conclude contracts in the name of the enterprise," unless the agent is an independent agent acting in the ordinary course of its business (the independent agent carve-out). An agent is regarded as independent where it is legally and economically independent from its principal.

The OECD proposes to change both parts of this test. The overall purpose of these proposed changes is to ensure that where the activities an intermediary...