Attribution of profits to Permanent Establishments Post BEPS

Attribution of profits to Permanent Establishments – Post BEPS situations Dr. Vikram Chand Executive Director, Executive Tax Education, University of Lausanne vikram. chand@unil. ch

Principles for taxation of business profits under treaty rules: Pre and Post BEPS Article 7 The residence State shall tax Para 1 Various Models The source State can tax if a PE arises Para 1 Article 5 Pre and Post BEPS Action 7 Para 3 Fixed Place PE Construction PE Para 5 & 6 Agency PE (broadened) – 31 Para 4 Exceptions to the PE (narrowed) – 41 Takeaway: MLI Implementation: non-uniform adoption by States

Attribution of profits to a PE Article 7(2)-7(5): 2008 OECD Model AOA: Partial alignment with ALP Focus on SPF with references to formulary approaches Article 7(2): 2010 and AOA: Full alignment with the ALP subsequent OECD Models Focus on SPF Article 7 2011 UN Model Does not agree with the AOA Focus on ALP and formulary approaches Takeaway: Attribution of profits depends on the wording of the tax treaty. States follow AOA or non AOA principles. Uniform attribution rules do not exist among States * AOA: Authorized OECD Approach/ ALP: Arm’s length principle / SPF: Significant people functions

Artificial avoidance Attribution of profits toofa PE PE status through specific activity exemptions

Article 5(4)(a) – The new provision Notwithstanding the preceding provisions of this Article, the term “permanent establishment” shall be deemed not to include: a) the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise; provided that such activity… of the fixed place of business, is of a preparatory or auxiliary character

Article 5(4)(a) – Delivery of fruits through a bonded warehouse Facts: State R Co A Fruit seller State S Bonded Warehouse USD 1000 u Co A (fruit exporter) sells fruits to customers in State S u The fruits are delivered to a bonded warehouse with special gas facilities in State S u The warehouse is operated only to protect the quality of the fruits till the time they are given a customs clearance Business income Delivery Clients u The customers pick up the fruits from the warehouse u Does the exemption of Article 5(4)(a) apply to this case?

Article 5(4)(a) – Online sales through a warehouse Facts: State R R Co Online retailer State S Warehouse USD 1000 Business income u Online retailer buys goods and sells goods through an online platform in State S u The customer from State S log on to the website and place an order for the product u The products are delivered to the customers from a warehouse that R Co operates in State S Delivery Clients u Around 50 people do the storage and delivery activity u Does the exemption of Article 5(4)(a) apply to this case?

Online sales through a warehouse – Attribution of income Facts: State R R Co Online retailer State S Warehouse PE u The warehouse is rented for USD 30 u The salary cost of the fifty employees doing the storage and delivery is USD 15 u The costs for delivering the products, such as post or courier, to customers amounts to USD 5 u A comparable search indicates that independent parties providing warehousing services usually earn a net margin of 10% on operating costs u Question: How would you attribute income to the PE of Online retailer? USD 1000 Business income Delivery Clients

Possible solution under Article 7 Profit and Loss account of the PE of R Co Income 55* Rent for warehouse 30 Salary costs 15 Delivery costs 5 Expenses 50 Profit Before Interest and Taxes 5* *represents a operating cost plus 10% mark up

Article 5(4)(d) – The new provision Notwithstanding the preceding provisions of this Article, the term “permanent establishment” shall be deemed not to include: d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise ; provided that such activity… of the fixed place of business, is of a preparatory or auxiliary character

Purchase of goods – core activity Facts: u R Co is a distributor of agriculture products State R R Co u R Co maintains a fixed place of business in State S u Employees working in the fixed place: Distributor State S Fixed place for Sale of goods § have special knowledge of this type of product procurement § they visit the suppliers on a regular basis to determine the type/quality of the products § The employees actively negotiate and conclude contracts for the acquisition of the products by RCO Suppliers u Does the exemption of Article 5(4)(d) apply to this case?

Purchase of goods – core activity – Attribution of income Facts: State R R Co u The supplier costs (purchase) amount to USD 30 u The salary cost of the employees carrying put the activities is USD 10 u The cost of renting the premises is USD 9 u The other operating costs amount to USD 1 u A comparable search indicates that independent parties engaged in procurement operations (unrelated suppliers) usually earn a net margin of 10% on operating costs u Question: How would you attribute income to the procurement PE of the distributor ? Distributor State S Fixed place for Sale of goods procurement Suppliers

Possible solution under Article 7 Profit and Loss account of the PE of R Co Sales Income 55* Purchase of goods 30 Salary costs 10 Rent 9 Other costs 1 Expenses 50 Profit Before Interest and Taxes 5* *represents a operating cost plus 10% mark up

Purchase of goods – non core activity Facts: State R R Co u R Co is a large distributor of agriculture products with more than thousand employees u R Co maintains a fixed place of business in State S u Employees working in the fixed place are responsible to source office supplies u Does the exemption of Article 5(4)(d) apply to this case? Distributor State S Fixed place for Sale of goods procurement Suppliers

Artificial avoidance of PE Attribution of profits to a PE status through commissionaire arrangements and other similar strategies

Multilateral Convention Clause – Specific provision in Article 12 …The term “permanent establishment”, but subject to paragraph 2, where a person is acting in a Contracting Jurisdiction to a Covered Tax Agreement on behalf of an enterprise and, in doing so, habitually concludes contracts, or habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise, and these contracts are: b) for the transfer of the ownership of, or for the granting of the right to use, property owned by that enterprise or that the enterprise has the right to use; that enterprise shall be deemed to have a permanent establishment in that Contracting Jurisdiction…

Pre BEPS – Commissionaire Co B Commissionaire A re rms m fo un leng un r se erat th de rvi ion r A ce rt. s 9 Clients Business income – USD 1000 Co B Commissionaire State A State B

Post BEPS – Attribution of income Question: Under the AOA does the DAPE carry out any SPF that deserves remuneration under Art. 7? Answer: NO Co B Commissionaire A se rem rms rv un le ice er ng s u ati th nd on er for Ar t. 9 State A * DAPE: Dependent Agent PE DAPE Business income – USD 1000 Clients Co B Commissionaire State B

Online advertiser – Pre BEPS Contract Clients Co A Online services Business income – USD 1000 A se rem rms rv un le ice er ng s u ati th nd on er for Ar t. 9 State A Co B Marketing services u Employees convince customers to buy online services u Employees discuss the prices for the services u Contract is concluded with Co A State B

Online advertiser – Post BEPS – Attribution of income Question: Under the AOA does the DAPE carry out any SPF that deserves remuneration under Art. 7? Answer: NO Co A Online services A se rem rms rv un le ice er ng s u ati th nd on er for Ar t. 9 State A * DAPE: Dependent Agent PE DAPE Business income – USD 1000 Clients Co B Marketing services State B