Comments on definition of permanent establishment in the OECD Model Tax Convention: October 17, 2003.

• Position: Organization for Economic Cooperation and Development

On October 17, 2003, Tax Executives Institute filed the following comments with the Organisation of Economic Cooperation and Development of the definition of permanent establishment under the OECD Model Tax Convention. The comments were prepared under the aegis of TEI's European Chapter, whose president is Guy A. Kersch of Pharmacia Enterprises S.A. Contributing material to the preparation of the comments were Peter H. Taylor of Du Pont de Nemours International, Clive M. Baxter of A.P. Moller, Mary Carol Holbert of J.T. International, Mark D. Kuck of Lexmark International Technology S.A., and Hilary A. Robinson of Kodak Ltd.

Tax Executives Institute is the preeminent organization of business tax professionals with 53 chapters in North America and Europe. Our 5,400 members represent approximately 2,800 of the leading corporations in the United States, Canada, and Europe. TEI is a non-profit organization that represents a cross-section of the business community; it is dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and governments alike. As a professional association, TEI is firmly committed to maintaining tax systems that work--systems that are administrable and with which taxpayers can comply.

TEI has a chapter in Europe with nearly 200 members and the majority of TEI members work for multinational companies with substantial international operations and sales. Members of TEI are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the various tax laws relating to the operation of business enterprises. Consequently, TEI members have a special interest in the definition of permanent establishment in the OECD Model Tax Convention on Income and on Capital.

The Importance of the OECD Model Treaty In Establishing a Level Playing Field

For 40 years the OECD Model Tax Convention on Income and on Capital (hereinafter referred to as the "Model Treaty" or "Model Convention") has framed the rules by which companies operating in more than one country may be safeguarded against double taxation. The Model Treaty reflects a multinational consensus on the general rules governing the jurisdiction to tax business profits across borders by requiring the finding of a permanent establishment (PE) in the jurisdiction seeking to impose the tax. In promoting the establishment of a global network of bilateral double taxation treaties based on common principles, terms, and structure, the Model Treaty enhances the ability of enterprises to plan efficient and effective marketing routes with confidence that only a single level of tax will apply to their revenues. Thus, the Model Treaty fosters the development of trade and encourages economic growth.

The Model Treaty has a particularly important role to play in cases where the tax conventions signed between the Contracting States contain terms that are not defined in the domestic law of one (or both) of the Contracting States. In these circumstances, the Model Treaty and its Commentary become a guide for interpreting the terms of an existing convention.

According to Paragraph 27 of the Model Treaty's introduction, the Convention seeks, wherever possible, "to specify for each situation a single rule." To permit "efficient implementation of the Model Convention," however, it "was thought necessary to allow for a certain degree of flexibility" to the Contracting States. TEI suggests that this degree of flexibility applies to the selection of the language agreed upon during the negotiation of specific treaties, but not to their subsequent interpretation. Uncertainty in the interpretation of fundamental concepts should be minimized, especially in the critical areas that may involve multiple and potentially significant tax liabilities.

Article 5's Definition Of Permanent Establishment

Article 5 of the Model Treaty defines what constitutes a "permanent establishment" for tax purposes. Under this article, there are two--and only two--ways in which an enterprise may be found to have a PE:

* Paragraph 1 establishes a physical presence test by requiring a "fixed place of business through which the business of an enterprise is wholly or partly carried on." This definition is supplemented by paragraphs providing examples of a PE (a "positive list"), excluded activities (a "negative list"), and certain exceptions for building sites or construction projects.

* Paragraph 5 provides that certain agencies may also create a PE but requires that a person be acting on behalf of an enterprise and have--and habitually exercise--in a Contracting State an authority to conclude contracts in the name of the enterprise, with exceptions for certain activities (such as storage facilities) listed in Paragraph 4 of the Model Treaty.

In addition, subsection (e) of Article 5(4) provides a general exception excluding the maintenance of a place of business for activities of a "preparatory or auxiliary" character.

Stated affirmatively, the interaction of Articles 5(1) and 5(5) demonstrates that a Contracting State acquires taxing jurisdiction over a non-resident entity (NRE) only if that enterprise has--

* a fixed place of business caused either by operation of assets of the NRE located in the Contracting State or the action in that state of individual persons in a paid-employment relationship with the...