On December 23,2014, TEI submitted comments to the OECD regarding its Public Discussion Draft on BEPS Action 7: Preventing the Artificial Avoidance of PE Status. TEI's comments focused on the need for any changes to the definition of a permanent establishment in the OECD Model Tax Convention to be clear so that taxpayers and tax authorities may apply the new definition with certainty and avoid unintended tax consequences and controversy. TEI's comments were prepared under the aegis of TEI's European Direct Tax Committee, whose chair is Nick Hasenoehrl. Benjamin R. Shreck, TEI Tax Counsel, coordinated the preparation of TEI's comments.
On 19 July 2013, the OECD published an Action Plan on Base Erosion and Profit Shifting (hereinafter the Plan) setting forth 15 actions the OECD will undertake to address a series of issues that contribute to the perception that individual countries' tax bases are being eroded or profits shifted improperly. Pursuant to Action 7 of the Plan, "Prevent the artificial avoidance of PE status," the OECD issued a public discussion draft on 31 October 2014 (hereinafter the Discussion Draft or Draft). The Discussion Draft recommends modifications to the definition of a permanent establishment (PE) in Article 5 of the OECD's Model Tax Convention on Income and Capital (Model Convention). The modifications address when certain activities conducted by a multi-national enterprise (MNE), or an agent acting on behalf of the MNE, will constitute a PE of the enterprise.
The OECD requested comments on the Discussion Draft no later than 9 January 2015. On behalf of Tax Executives Institute, Inc. (TEI), I am pleased to respond to the OECD's request for comments. In addition, TEI requests the opportunity to speak in support of these comments at the public consultation meeting on the Action 7 Discussion Draft, scheduled for 21 January 2015 in Paris.
TEI was founded in 1944 to serve the needs of business tax professionals. (1) Today, the organisation has 56 chapters in Europe, North and South America, and Asia. As the preeminent association of in-house 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 individual members represent over 3,000 of the largest companies in the world.
TEI commends the OECD for recommending changes to the definition of a PE in the Model Convention itself rather than modifying the OECD's official commentary on the Convention (the Commentary). Changes to the Commentary are more susceptible to differing interpretations among tax authorities. Moreover, in certain cases, changes to the Commentary may effectively amend the language of the Model Convention without the deliberative process required for amendments to the Convention. Modifying the language of the Model Convention will more likely lead to consistent application of PE definition across tax authorities, which will provide certainty for taxpayers and result in less controversy and litigation. In addition, TEI welcomes the continued focus on physical presence in the general definition of a PE under paragraph 1 of Article 5--"a fixed place of business through which the business of an enterprise is wholly or partly carried on"--which remains undisturbed in the Draft.
Article 5 of the Model Convention was designed, in part, as a kind of "safe harbour" to avoid or minimise international disputes regarding taxing jurisdiction between source and resident countries. By both broadening the definition of a PE and limiting the exceptions to that definition, the Discussion Draft moves the tax jurisdictional line in favor of the source country. The impetus for this move is primarily tax authority dissatisfaction with commissionnaire structures that do not constitute a dependent agency arrangement under paragraph 5 of Article 5 and the perceived improper exploitation of the specific activity exceptions in paragraph 4. The move towards source country taxation and a broader reach of the PE definition, however, is in tension with the OECD's work on transfer pricing documentation under Action 13 of the Plan and the requirement of a detailed value chain and economic analysis to set appropriate transfer prices. A proliferation of PEs within an MNE's operations will only complicate this analysis when determining the proper amount of remuneration between a PE and the rest of the enterprise.
Moreover, it should be unsurprising that MNEs strive to avoid creating a PE in a particular jurisdiction just as they strive to avoid double taxation in transfer pricing matters between jurisdictions. An unanticipated PE assertion may result in unexpected --and potentially drastic--tax consequences, an exacerbated compliance burden, and double taxation. Just as unsurprisingly, these potentially drastic consequences incentivise tax authorities to assert a PE. Indeed, in the experience of TEIs members, some countries go so far as to assert a PE to force MNEs to settle on unrelated transfer pricing issues, or even as a way to "make up" for taxes the authorities are unable to collect on transfer pricing matters. The OECD should recognise that it indirectly encourages tax authorities in these endeavors by introducing unnecessary uncertainty into the PE definition while also lowering the PE threshold.
Regrettably, the Discussion Draft: begins on the wrong footing by stating that "in many cases commissionnaire structures and similar arrangements were put in place primarily in order to erode the taxable base of the State where the sales took place." (2) Elsewhere, the Discussion Draft labels certain taxpayer arrangements as an "abuse" (3) or not in conformance with the "original purpose" (4) of Article 5 of the Model Convention. Proceeding from the premise that most, if not all, of the arrangements described in the Discussion Draft are "artificial" has apparently freed the OECD to propose sweeping changes to the PE definition. These changes, however, are either more appropriate to abusive situations, such as the ability of tax authorities to ignore separate legal entities and recharacterise contracts, or would be better effected elsewhere, such as through transfer pricing rules. No matter which of the various options in the Draft the OECD chooses in the final amendments to Article 5, the changes to the PE definition will increase the uncertainty of when an enterprise's activities, or the activities of an agent, will give rise to a PE as compared to the current rules. This will result in more controversy and litigation, consuming both taxpayer and tax authority resources.
Elimination of Commissionnaire Structures and Similar Arrangements (Options A through D)
As noted, the Discussion Draft generally views commissionnaires as structured "primarily" to permit MNEs to erode the tax base of the State of sale. There is no discussion, however, of the commissionnaire as a legitimate business arrangement often used by unrelated parties to conduct their respective enterprises. The Draft thus offers no analysis of why a commissionnaire should be considered an "artificial" mechanism when used by an MNE to operate its business. The Discussion Draft adopts this view of commissionnaires across the board, even in cases when a commissionnaire approach best reflects the relationships in place within an MNE, which are generally organised for legitimate business reasons (such as delineating delegations of authority and responsibilities, reducing compliance costs, or avoiding tax volatility). Indeed, in some cases a commissionnaire structure may result in an increased profit allocation to a high tax jurisdiction, which is hardly evidence of source State base erosion.
In this regard, it is worth noting that many, if not most, MNEs generally no longer take a country-by-country "silo" approach to their affairs by constructing a separate, fully integrated operation in each jurisdiction. Instead, operations take place on a worldwide basis with a more homogenous approach to the activities conducted in a particular jurisdiction when compared to other jurisdictions. MNEs generate product demand through global advertising rather than via sales personnel "on the ground" negotiating and concluding contracts with customers in individual countries. In this business environment, utilising a commissionnaire arrangement in individual jurisdictions makes commercial sense from a cost minimisation standpoint by eliminating the need for a fully integrated, local sales and distribution operation, whether or not an MNEs local tax burden is reduced. A commissionnaire structure is also relatively simple as it allows an MNE to concentrate its inventory ownership in a single company within an MNE group.
Nevertheless, the OECD has clearly concluded that commissionnaire and similar arrangements must be eliminated, at least between related parties. The Discussion Draft thus proposes four alternative amendments to paragraphs 5 and 6 of Article 5 of the Model Convention (referred to as Options A through D), each of which would likely eliminate the commissionnaire arrangement. Each of these options, however, also come with potentially negative collateral consequences for both taxpayers and tax authorities.
Before commenting on Options A through D, it bears noting that while a commissionnaire may result in the reduction of the local tax base in certain circumstances, restoring a "fair allocation" of taxation rights--in this case by eliminating commissionnaires--will not necessarily mean an increase in local taxable profits. In a number of industries, overall profit margins are much lower than prior to the 2008 financial crisis. Thus, while a commissionnaire has low--but also stable and positive--profits, this does not mean that the foreign principal is enjoying excessive profits (as the example in paragraph...