Attribution of profits to Permanent Establishments – Post BEPS situations

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

2. Principles for taxation of business profits under treaty rules: Pre and Post BEPS The residence State shall tax Article 7 Various Models Para 1 The source State can tax if a PE arises Para 1 Fixed Place PE Article 5 Pre and Post BEPS Action 7 Para 3 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

3. Attribution of profits to a PE AOA: Partial alignment with ALP Focus on SPF with references to formulary approaches Article 7(2)-7(5): 2008 OECD Model AOA: Full alignment with the ALP Focus on SPF Article 7(2): 2010 and subsequent OECD Models Does not agree with the AOA Focus on ALP and formulary approaches Article 7 2011 UN Model 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

4. Attribution of profits to a PE Artificial avoidance of PE status through specific activity exemptions

5. Article 5(4)(a) – The new provision • Notwithstanding the preceding provisions of this Article, the term “permanent establishment” shall be deemed not to include: • 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

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

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

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

9. Possible solution under Article 7 *represents a operating cost plus 10% mark up

10. 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

11. Purchase of goods – core activity • Facts: • R Co is a distributor of agriculture products • R Co maintains a fixed place of business in State S • Employees working in the fixed place: • have special knowledge of this type of product • 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 • Does the exemption of Article 5(4)(d) apply to this case? State R R Co Distributor State S Fixed place for procurement Sale of goods Suppliers

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

13. Possible solution under Article 7 *represents a operating cost plus 10% mark up

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

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

16. 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…

17. Pre BEPS – Commissionaire Co B Commissionaire Clients Business income – USD 1000 Arms length remuneration for services under Art. 9 Co B Commissionaire State A State B

18. Post BEPS – Attribution of income Question: Under the AOA does the DAPE carry out any SPF that deserves remuneration under Art. 7? Answer: NO DAPE Co B Commissionaire Clients Business income – USD 1000 Arms length remuneration for services under Art. 9 Co B Commissionaire State A State B * DAPE: Dependent Agent PE

19. Online advertiser – Pre BEPS Contract Co A Online services Clients Business income – USD 1000 Arms length remuneration for services under Art. 9 Co B Marketing services • Employees convince customers to buy online services • Employees discuss the prices for the services • Contract is concluded with Co A State A State B

20. 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 DAPE Co A Online services Clients Business income – USD 1000 Arms length remuneration for services under Art. 9 Co B Marketing services State A State B * DAPE: Dependent Agent PE