Business profits of a foreign enterprise are taxable in a State only to the extent that the foreign enterprise has a Permanent Establishment (PE) in that state. The definition of a PE in tax treaties is therefore critical in determining if the profits of a non-resident will be taxable in another State.

Due to tax avoidance strategies being used to circumvent the existing PE definition and shift profits out of the country where the sale took place, the Action Plan on Base Erosion and Profit Shifting (BEPS Action Plan, OECD, 2013a) called for a review of the PE definition. The changes made in the final report will seek to prevent the exploitation of the specific exceptions to the PE definition currently provided for by Art.5(4) of the OECD Model Tax Convention (2014) which bears particular relevance to the digital economy.

The “Artificial avoidance of PE establishment status through commissionnaire arrangements and similar strategies”, which was one of the amendments to article 5 of the OECD model tax treaty, will be briefly discussed below.

Artificial avoidance of PE establishment status through commissionnaire arrangements and similar strategies

Simply put, a commissionaire arrangement refers to an arrangement where a person sells products in a given State in its own name but on behalf of a foreign enterprise that is the owner of these products. The foreign enterprise is therefore able to sell its products in a State without having a permanent establishment and hence no tax exposure in that State.

The revised discussion draft proposes to modify paragraphs 5 and 6 of Article 5 which will lower the PE threshold and tighten the independence criteria.

Lowering the threshold for creating a PE

Paragraph 5 previously required the actual conclusion of contracts for a deemed PE to be created.

Paragraph 5 of Article 5 now states that a PE is deemed to have been formed when a person acting on behalf of an enterprise habitually concludes contracts, or negotiates the material elements of contracts that are;

  1. In the name of the enterprise
  2. For the transfer of ownership of or granting of right to use property owned by the enterprise, or that the enterprise has the right to use
  3. For the provision of services by that enterprise 

 

The commentary to the above paragraph refers typically to persons who convinced the third party to enter into a contract with the enterprise. The changes to paragraph 5 will also apply to contracts that create obligations that will effectively be performed by such enterprise (the foreign enterprise) rather than the person with whom the contract was concluded. This however excludes buy-sell distributors (including low-risk distributors) with the condition that transfer of the title to property sold by that “low-risk” distributor, passed from the enterprise to the distributor and from the distributor to the customer (regardless of how long the distributor would hold title in the product sold).

Revision of the Independence requirement in Paragraph 6 of Article 5

The changes to this paragraph aims to tighten the requirements required for an agent to be considered independent. The previous draft contained the provision that an agent acting on behalf of a related enterprise could still be considered as an independent agent.

A PE will not be created if activities are carried out by an independent agent acting in the ordinary course of its business. An agent will however not be considered independent if the agent acts exclusively or almost exclusively on behalf of one or more enterprises to which it is closely related and this lack of independence could result in the creation of a PE.

Paragraph 5 of Article 6 therefore states that a person must be carrying on a business as an independent agent and be acting in the ordinary course of that business, while the commentary to Paragraph 6 states that it is possible that a subsidiary will act on behalf of its parent in such a way that the parent will be deemed to have a permanent establishment under paragraph 5.

Businesses and companies involved in commissionnaire arrangements should therefore familiarise themselves with these changes in order to avoid any unintended consequences.

Ozeyr Ahmed

Manager | Corporate Tax Compliance, Johannesburg

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