OECD: interpretation and application of article 5 (permanent establishment) of the OECD Model Tax Convention.

PositionOrganisation for Economic Co-operation and Development

February 17, 2012

On February 17, 2012, Tax Executives Institute filed the following comments with the Organisation for Economic Co-operation and Development regarding the OECD's discussion draft on the Interpretation and Application of Article 5 (Permanent Establishment) of the OECD Model Tax Convention, released on October 12, 2011. The OECD discussion draft proposes significant changes to the official commentary to Article 5 of the model convention, and TEI's comments focus on many of the 25 separate issues addressed by the discussion draft. The comments were prepared by a working group under the aegis of TEI's European Direct Tax Committee, whose chair is Anna Theeuwes of Shell International B.V. Nick Hasenoehrl of Haemonetics Corporation led the working group, and other significant contributors included Peter H. Taylor of DuPont International, Janice L. Lucchesi of Akzo Nobel Inc., Karina O of Telus Corporation, and Alexendar Koelbl of General Dynamics. Benjamin R. Shreck, TEI Tax Counsel, is staff liaison to the European Direct Tax Committee and coordinated the preparation of the comments.

On behalf of Tax Executives Institute, I am pleased to respond to the OECD's request for comments on proposed changes to the official commentary to Article 5 of the OECD Model Tax Convention. Article 5 (Permanent Establishment) of the Convention includes the definition of the treaty concept of a permanent establishment (PE), which is primarily used to allocate taxing rights when an enterprise of one State derives business profits from another State. The OECD's Committee on Fiscal Affairs (CFA), through a subgroup of its Working Party No. 1 on Tax Conventions and Related Questions, has examined various questions related to the interpretation and application of the definition of a PE. This examination culminated in the release of a discussion draft regarding the Interpretation and Application of Article 5 (Permanent Establishment) of the OECD Model Tax Convention (the Discussion Draft) on 12 October 2011. The Discussion Draft proposes several modifications to the official Commentary on Article 5 of the OECD Model Tax Convention (Commentary) interpreting the PE concept, and invites public comments on the proposed modifications.

In general, Tax Executives Institute is concerned that, while there is much to be commended in the Discussion Draft, some parts of the proposed changes to the Commentary may regrettably increase uncertainty and thereby exacerbate the number, scope, and degree of controversies between taxpayers and taxing authorities as well as among taxing authorities themselves.

TEI Background

Tax Executives Institute was founded in 1944 to serve the needs of business tax professionals. Today, the organisation has 55 chapters in North America, Europe, and Asia. As the preeminent association of business tax professionals worldwide, TEI has a significant interest in promoting tax policy, as well as the fair and efficient administration of the tax laws, at all levels of government. Our nearly 7,000 members represent 3,000 of the largest companies in the United States, Canada, Europe, and Asia.

Discussion Draft Background

The Discussion Draft addresses 25 separate issues related to the PE definition that were previously identified by the CFA, including its work on business restructurings and in comments from the OECD Business and Industry Advisory Committee (BIAC). The Discussion Draft recommends changes to the Commentary for most of these 25 issues. The Annex to the Discussion Draft contains a comprehensive list of all the recommended changes to the Commentary.

General Comments on the Discussion Draft

TEI commends the OECD for issuing its Discussion Draft for public consultation. We believe that the proposals represent an important step in applying the PE concept to today's global business environment and facilitating cross-border commerce. Whether a PE exists or not remains one of the most important determinations under most bilateral tax conventions and the OECD has led the way in providing guidance in this area. The Discussion Draft contains helpful statements on the role of taxpayers and tax authorities as well of the application of the PE concept under the OECD Model Tax Convention. TEI supports the OECD's attempts to foster a harmonised interpretation and application of the PE concept and to discourage OECD Members States from making reservations on certain issues. Consistently interpreted and applied international tax rules are in the interest of tax authorities and taxpayers; they will minimize discrepancies, reduce controversies and promote cross-border trade.

There are, however, aspects of the Discussion Draft with which we disagree. These areas are discussed in detail below. Before turning to the Discussion Draft on an issue-by-issue basis, we offer the following observations:

* The Discussion Draft does not offer a comprehensive approach to the PE concept. In TEI's view, such an approach would focus on (i) clarifying the determination of a fixed place of business, (ii) issues related to dependent agents concluding contracts, and (iii) clear exceptions for preparatory and auxiliary activities. Unhelpfully, certain portions of the Discussion Draft lend support to the notion of an "activity" or "services" PP, which would lead to unnecessary controversy.

* Electronic commerce, as well as nontraditional work relationships (such as "working from home"), have been addressed in the Discussion Draft, but again not through a consistent comprehensive approach. Rather, the draft proceeds on an "issue by issue" basis.

* The proposed changes in the Discussion Draft could lead to unintended results (such as when combining issue number two regarding the meaning of "at the disposal of" and issue number three regarding certain business restructurings). We recommend that the OECD expressly address the consequences of the interaction of the proposed changes and their intentional and potential unintended consequences.

Comments Relevant to Specific Issues in the Discussion Draft

The following comments address Discussion Draft issues of particular relevance to TEI and its members. No inference should be drawn from the failure to address other issues.

1. Issue #2: Meaning of "at the disposal of" (paragraph 4.2 of the Commentary)

Paragraphs 4 to 4.2 of the Commentary explain that a place of business may constitute a PE of a business enterprise if that place is "at the disposal" of the enterprise. The concept of "at the disposal" is not found in the definition of a PE in Article 5, but instead is set forth in paragraph 4 of the commentary to explain the concept of "place of business." The proposed changes to the Commentary clarify that, when examining whether a location is at the disposal of an enterprise, the extent of the presence of the enterprise in that location and the activities it performs there are relevant. For example, when an enterprise has an exclusive legal right to use a particular location to carry on its activities and that location is only used for such activities, or when it performs activities on a continuous and regular basis for an extended period of time at a location that belongs to another enterprise or that is used by a number of enterprises, that location is considered to be at the first enterprise's disposal. The Discussion Draft explains, however, that this should not be the case where the enterprise's presence in a location is so intermittent or incidental that the location cannot be considered a place of business of the enterprise or where an enterprise does not have a right to be present at a location and in fact does not use that location.

In general, TEI believes that the proposed changes signal a move away from the requirement under the general PE definition in paragraph 1 of Article 5 that there be a "fixed place of business" of an enterprise and toward finding that an activity being carried on somewhere in the source country for an extended (but undefined) period of time constitutes a PP. In other words, the changes may sanction the creation of an activity or services PP, permitting the PE determination to be based upon services rendered. Regrettably, such a development would discourage cross-border economic activity without efficiently increasing tax revenue.

On the other hand, absent a more comprehensive approach to the PE concept, we believe an expansion of the list of exceptions to the PE definition is an acceptable approach for guiding multi-national enterprises (MNEs) on permitted activities. For example, the language in paragraph 4.2 concluding that the location of a supplier or contract manufacturer will not be deemed to be at the disposal of the enterprise that receives the goods is helpful.

TEI believes the Discussion Draft requires further clarification in respect of the level of permitted services. In particular, the example discussed in paragraphs 13 and 14 regarding a consultant conducting training for 20 months at a client's location does not provide a rationale for its conclusion that the activity creates a PE. While many MNEs provide training, they would not consider themselves to have a PE in each location where the training takes place. For example, would the conclusion be the same if the training contract did not specify where on the client's premises the training was to take place, such that there was no place that could be considered "at the disposal" of the consultant? What if the training took place at a third party's premises (such as a hotel), but nevertheless case the training took place for 20 months? Alternatively, what if the training were for 7 or 13 months? Additional explanation of the significance of these facts in the example, and for services generally, would be welcome.

Finally, TEI believes that the Commentary should clarify that procurement activities, even if they are extensive enough to require that the supplier's premises be "at the...

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