Wout Moelands, Hamir Khatau and Richard Collier, PwC UK
Until the work of the OECD is completed, we can expect more frequent and assertive PE challenges, including the international origination arrangements conducted by travelling bankers or representative offices of banks.
The PE rules provide tax authorities with a means to increase their international tax take by taxing activities undertaken by overseas companies within their borders; either through challenging the PE status of business operations in their country, or, if it has been established that a PE exists, by challenging the profit attribution to that PE. At the same time, tax authority willingness to assert the existence of PEs and to seek to apply PE rules is increasing globally; the US Internal Revenue Service (IRS) has been hiring more dedicated personnel to consider PEs; and the UK's Her Majesty's Revenue and Customs (HMRC), the ATO (Australia) and the Inland Revenue Authority (IRA) of Singapore have provided specific guidance on the establishment and treatment of PEs. Furthermore, it has been a recent focal point for the United Nations and the OECD (evidenced by “the OECD Model Tax Convention: Revised Proposals concerning the Interpretation and Application of Article 5” published in 2012; and as part of the BEPS Action Plan published in July 2013).
One area within the financial services industry that may be specifically prone to challenges on PE status concerns (investment) banks and the origination activities performed by representative offices and travelling bankers. As such, in this article we set out certain considerations that need to be taken into account in analysing the PE status for travelling bankers based on the current OECD Model Tax Convention and the 2012 Commentary. First, however, we address the relevant action points from the OECD BEPS Action Plan in relation to the PE status test.
The BEPS Action Plan addresses two specific points of interest in relation to the PE test. The first of these points deals with commissionaire structures where there is a de-risking of the local operations (i.e., with the intention of converting the local operations into a commissionaire) and a shift of profit to a central location (i.e., to which the risk is transferred); however, there is no substantive change of functions performed at the local operations. The second point considers those situations where multinational companies may artificially fragment their operations among various group entities to qualify for the exceptions to PE status for preparatory and auxiliary activities.
As provided in the BEPS Action List (Action Point 7), the OECD will pursue further work on the Dependent Agent test in Article 5.5 of the OECD Model Tax Treaty and on the provisions dealing with preparatory and auxiliary activities in Article 5.4 of the Treaty. This work is aimed to be completed within two years.
Until the work of the OECD is completed, we can expect more frequent and assertive PE challenges, including the international origination arrangements conducted by travelling bankers or representative offices of banks. Currently, we are already experiencing increased tax authority activity in this respect: PE analyses are being requested as part of advance pricing agreement (APA) applications; there is evidence of transfer pricing arrangements being scrutinised on the grounds of PE; and erratic application of the rules in some locations is an increasing problem.
Below, we have dealt with certain key characteristics and practical implications that need to be addressed in analysing the PE status of travelling bankers. We will look at these in the order of the relevant paragraphs of Article 5 of the OECD Model Tax Convention. In particular, we will address certain key considerations in relation to the exceptions to PE status for preparatory and auxiliary activities.
The essential characteristics of a PE per Article 5(1) include a place of business that is fixed and through which the business of the enterprise is carried on. Considering the day-to-day activities of the bankers (i.e., travel regularly to meet (potential) clients and often using the offices of local affiliates), the first characteristic to be addressed is whether there is a place of business in the countries the bankers are visiting. In this respect, an office is explicitly mentioned in Paragraph 2 of Article 5(1) in relation to what includes a fixed place.
The second characteristic to consider is whether the office would be a 'fixed’ place of business. Although the Commentary on Article 5 provides a six month 'cut-off’ practical example (rather than a definitive rule) the 2012 Revised Proposal indicates that if the business concerned is conducted in its entirety for a short duration only; or if the activity is performed recurrently for a short duration consistently over a number of years this could cause a PE. Other practical implications in analysing whether a place of business would be fixed, and for which there is no conclusive guidance, includes how the days need to be counted. In considering this, there is currently no clarity on the point at which a PE may arise. (e.g., if more than one banker is in a certain country on one day, should that day be counted as one day or more than one day). The final characteristic to be considered is whether the 'fixed place’ is a 'fixed place of business’. In determining what activities would be considered carrying on the business of the enterprise, Article 5(4) of the OECD Model Tax Convention and the Commentary state that auxiliary and preparatory work would not be considered as 'carrying on a business’.
“but the services it performs are so remote from the actual realisation of profits that it is difficult to allocate any profit to the fixed place of business in question,”
the respective company shall not be deemed to have a PE. As such, where a fixed place of business exists, but only auxiliary and preparatory services are being performed, no PE would be created. On this point, the OECD has inserted some additional wording in the 2012 Revised Proposal indicating that multinationals sending employees to merely visit the offices of a subsidiary would typically not create a PE. However, the activities of travelling bankers would typically exceed merely visiting the office of a subsidiary. Therefore, more clarity on what would be considered as carrying on a business is required and will hopefully be addressed in the work the OECD is anticipating carrying out as part of Action Point 7 of the BEPS Action List.
A dependent agent PE per Article 5(5) is constituted when a person other than an independent agent is acting on behalf of an enterprise and has and habitually exercises an authority to conclude contracts in the name of the enterprise.
In our example, the travelling bankers meet with (potential) clients for customer relationship purposes to promote the bank and to discuss the products and services the bank has to offer. As such, the key test in analysing the dependent agent PE status of the bankers is whether they habitually exercise an authority to conclude contracts in the name of their home office. To aid the interpretation of the meaning of this test, a new sentence was proposed in the 2012 Revised Proposal. This sentence states that in some countries an enterprise could be bound by a contract concluded with a third party by a person acting on behalf of the enterprise, even if the person did not formally disclose that it was acting for the enterprise and the name of the enterprise was not referred to in the contract. However, this proposed interpretation is rather vague and open to a wide range of interpretations.
Specifically, it may be interpreted as lending support to the “economically bound” interpretation of the dependent agent rule, i.e., it is sufficient for the test to operate if the foreign principal is economically bound by the contracts concluded by the person acting for it (assuming the other conditions of Article 5(5) are met).
Also here, the further work of the OECD on the Dependent Agent test in Article 5.5 as part of Action Point 7 of the BEPS Action List will hopefully provide more clarification.
Although not included in Article 5 of the OECD Model Tax Convention, the Commentary and certain double tax treaties (in particular in the tax treaties with certain Asian countries) include the Services PE. The Commentary provides the following example provision for a services PE to be constituted (by means of a twofold threshold test):
'where an enterprise of a Contracting State performs services in the other Contracting state through an individual who is present in that other State for: (i) a period or periods exceeding in the aggregate 183 days in any twelve month period, and more than 50 per cent of the gross revenues attributable to active business activities of the enterprise during this period or periods are derived from the services performed in that other State through that individual; or (ii)’a period or periods exceeding in the aggregate 183 days in any twelve month period, and these services are performed for the same project or for connected projects through one or more individuals who are present and performing such services’.
As with the fixed place of business PE, where the services are only of auxiliary and preparatory nature, no services PE is deemed to exist.
For travelling bankers, the second threshold is often the more relevant one as the gross revenues test is typically not met in our experience. However, if it has been agreed by contract to provide services through the employees of a separate enterprise (e.g. an enterprise providing outsourced services), the services performed through these employees will not be taken into account for purposes of the application of the second threshold and this rule applies regardless of whether the separate enterprise is associated to, or independent from, the company that entered into the contract.
PEs are on the agenda of tax authorities globally to widen their taxable base. One area within the financial services industry that may be specifically prone to challenges on PE status is the origination activities performed by travelling bankers. The analysis is complex and should consider the economic relations, the contractual relations etc.; however, there are still some uncertainties on how the rules need to be interpreted. As such, the additional work of the OECD identified in BEPS Action List may well be required to provide some further clarification in this respect.
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