TEI comments on OECD PE profit attribution draft.

• Position: Organisation for Economic Co-Operation and Development permanent establishments

On September 2,2016, Tax Executives Institute, Inc., submitted a letter to the OECD commenting on its July 4 public discussion draft regarding Additional Guidance on the Attribution of Profits to Permanent Establishments. The discussion draft consists of follow up guidance under Action 7 of the OECD's base erosion and profit shifting (better known as BEPS) project. The Institute's comments Included the need for more realistic examples of business operations and supply chains that might create permanent establishments, as well as the complexity and administrative burden created by the creation of a permanent establishment in the first Instance. TEI's comments were prepared under the aegis of the Institute's European Direct Tax Committee, whose chair is Nick Hasenoehrl. Benjamin R. Shreck, TEI Tax Counsel, coordinated the preparation of the Institute's comments.

**********

The Organisation for Economic Co-Operation and Development (OECD) published final reports pursuant to its base erosion and profit shifting (BEPS) project on October 5, 2015. The reports were the culmination of the OECD's Action Plan on Base Erosion and Profit Shifting (hereinafter the Plan) published in 2013. The Plan set forth 15 actions the OECD would undertake to address a series of issues that contribute to the perception of tax bases being eroded or profits shifted improperly. Included in the October 2015 final reports was the report under Action 7 of the Plan, Preventing the Artificial Avoidance of Permanent Establishment Status. Subsequently, the OECD issued a public discussion draft under Action 7 (the Discussion Draft) on July 4, 2016, requesting comments on fact patterns that would benefit from additional guidance concerning the attribution of profits to permanent establishments (PE).

I am pleased to respond to the OECD's request for comments on behalf of Tax Executives Institute, Inc. (TEI). TEI requests the opportunity to speak in support of these comments at the public consultation to be held on October 11-12, 2016, in Paris.

TEI Background

TEI was founded in 1944 to serve the needs of business tax professionals. Today, the organization 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 2,800 of the leading companies in the world. (1)

General Comments

TEI commends the OECD for providing stakeholders with the opportunity to comment on the issue of profit attribution to PEs. This opportunity is especially important because the BEPS project broadened the PE definition in Article 5 of the OECD's Model Tax Convention, which will result in cliff-like, negative tax effects of unexpected PEs of a multinational enterprise (MNE) in various jurisdictions.

TEI further appreciates the desire of the OECD Member States to use the OECD's transfer pricing principles to attribute profits to PEs, which could lead to clarity and a workable approach to such attribution if a consensus among the States can be reached. Regrettably, the additional guidance provided in the Discussion Draft regarding PE profit attribution is handicapped by the lack of consensus on underlying issues, particularly the definition and ownership of, and how to tax income from, intellectual property (IP). Thus, while use of transfer pricing methods and significant people functions to allocate revenue and assets to a PE could be viable, current and future attempts to provide additional clear guidance on predictable profit attribution standards will be muddled until fundamental definitional issues are settled. It is difficult to allocate assets based upon significant people functions if the assets cannot be identified. The incoherent tax climate and lack of consensus surrounding this issue will undoubtedly result in double taxation as tax administrators assess taxes on IP income under their own definition of IP and theories of IP taxation. For these reasons, TEI encourages the OECD to return to its efforts to define IP and devise methods of taxing the income it generates, which in turn should provide additional clarity to PE profit attribution.

Separately, while TEI appreciates the OECD's efforts reflected in the Discussion Draft, the Draft is unhelpful in many respects. While the OECD recognizes that there may be circumstances where there is no additional taxable profit attributable to a PE under the new, post-BEPS project Article 5 PE definition, the Draft only briefly mentions that there may be other consequences (2) and does not elaborate on their cost or administrative complexity. The varying fact patterns of complex modern business operations, combined with the newly expanded PE definition, may result in an MNE having, e.g., (i) multiple PEs, in addition to its local legal entities, in a particular jurisdiction, and (ii) a combined PE in a particular jurisdiction resulting from the operations of several of its separate, non-resident legal entities. This would create additional filing requirements, social security, payroll tax obligations, multiple VAT registrations, etc. In short, the expanded definition may impose a tremendously increased compliance burden on MNEs as additional PEs arise, even if such PE do not result in any additional local country profit. This is contrary to the OECD's stated intention not to create unreasonable additional compliance obligations for international business.

A more helpful approach, if the goal is to set the "correct" level of profit in each country, would be to adjust transfer prices between related entities. This would be simpler than creating additional PEs and engaging in a profit attribution exercise with its attendant complexity and compliance burden. For example, the collection of receivables and inventory management could be remunerated as services on a cost-plus basis rather than creating a PE. Alternatively, the OECD should provide further guidelines regarding what "other tax liabilities" may arise as a result of the PE determination as the short reference to such liabilities in paragraph 104 is insufficient. A compromise approach could be that, where a new PE arises under the BEPS Action 7 definition and where the parties are already appropriately remunerated at arm's length, adjustments are instead made under Article 9; that way the theoretical PE would be ignored for all other tax purposes. We discuss this further below in response to question 18.

The Discussion Draff also regrettably reduces the complex reality of business operations to basic examples. In general, the examples are oversimplified and the accompanying analyses often over complicated. The OECD should ensure that the final guidance includes more detailed examples, as we understand that the examples in the Discussion Draff are presented to address specific concepts and are not intended as overall guidance to tax administrators or taxpayers on how to attribute profits to these PEs.

Moreover, the Discussion Draff does not address the practical issues facing MNEs with potential multiple PEs in a jurisdiction (e.g., additional registration and filing requirements not just for income tax but also for social security, payroll taxes, indirect taxes, and customs purposes). While we understand that indirect taxes and customs in theory follow a separate...