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BEPS Action Plan 7 Preventing the Artificial Avoidance of Permanent Establishment Status

BEPS Action Plan 7 Preventing the Artificial Avoidance of Permanent Establishment Status. 15 June 2019. Background. Base Erosion and Profit Shifting (BEPS).

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BEPS Action Plan 7 Preventing the Artificial Avoidance of Permanent Establishment Status

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  1. BEPS Action Plan 7Preventing the Artificial Avoidance of Permanent Establishment Status 15 June 2019

  2. Background

  3. Base Erosion and Profit Shifting (BEPS) BEPS refers to tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations • BEPS Action Plans : 15 Action plans (AP) across 3 main pillars

  4. Action Plan 7 - Overview Permanent Establishment (PE): sole criteria of taxing business profits of foreign enterprise • Business profits of a foreign enterprise are taxable in a State to the extent attributable to the PE in that State • Establishment of PE also enables taxation of passive income [e.g. royalties, FTS, interest, capital gains] effectively connected to PE Present concept of PE [Article 5 of OECD] revolves around “substantial and physical presence” • Fixed place of business • Construction / Supervisory PE • Presence through dependent agents OECD suggested updating definition of PE to avoid the following: • Shifting profits out of the country of sales through “commissionaire arrangements” • Fragmentation of activities by MNEs to qualify for PE exceptions • Splitting up of contracts Action 7 aims to develop changes to the definition of PE to prevent artificial avoidance of PE status to address the BEPS strategies • Action agenda to be achieved through: • Amendments to OECD Model Convention (MC) • Signing of Multilateral Instruments (MLI) [AP 15] • Tax treaty renegotiations

  5. PE Concept – OECD Model Convention Article 5(1) - General Rule: PE must be a fixed place of business at the disposal of the enterprise through which the business of the enterprise is carried on. Article 5(2) -Contains a list of places of business, which prima facie constitute PE, provided they satisfy the requirements of Article 5(1). Article 5(3) - Special rule for construction & installation sites; limitation on Article 5(1). Article 5(4) - Lists activities, which may be carried on at a fixed place of business without giving rise to a PE. (EXCLUSIONS) Article 5(5) - Provides that dependent agents constitute PE on satisfaction of certain conditions Article 5(6) - Identifies certain forms of independent agents who do not constitute PE Article 5(7) - States that an associated company will not necessarily give rise to PE • 5(1) Fixed Place • 5(2) • Specific • 5(7) • Ass. Co • 5(3) • Construction • PE • 5(4) Exclusion • 5(6) Indep Agents • 5(5) • Dep Agent

  6. Key Concerns • Business profits of a foreign enterprise is taxable in a State to the extent attributable to its PE in that State • Concerns were mainly threefold: Exploitation of exemptions applicable for Preparatory and Auxiliary activities Use of commissionaire and similar arrangements to avoid Dependent Agent PE Artificial splitting up of contracts Business models have evolved significantly Activities that were considered ‘preparatory and auxiliary’ for conventional business are now core activities.Benefit from exceptions applicable to ‘preparatory and auxiliary’ activities are being obtained through fragmentation of business activities among closely related enterprises. Commissionaire Arrangements and similar strategies have been used by enterprises to overcome creation of a DAPE This involved situations where sales contracts substantially negotiated in a State are not concluded in that State because they were finalized or authorized in another State Artificial fragmentation of operations (particularly in construction contracts) between closely related enterprises has been used to abuse the provisions of tax treaties and avoid creation of PE

  7. Areas covered in Action Plan 7 • Artificial avoidance of PE through Commissionaire arrangements and similar strategies • Artificial avoidance of PE through specific activity exemptions • Exclusions in Article 5(4) • Anti-fragmentation rule • Splitting-up of contracts Recommendations of BEPS AP 7 have been incorporated under OECD MC 2017 and Commentary Also, India has accepted all the recommendations of BEPS AP 7 in its position on the relevant articles in MLI

  8. Analysis

  9. Article 5(5) & 5(6) Agency PE

  10. Article 5(5) of OECD MC Pre BEPS Post BEPS • Notwithstanding the provisions of paragraphs 1 and 2, where a person — other than an agent of an independent status to whom paragraph 6 applies — is acting on behalf of an enterprise and has, and habitually exercises, in a Contracting State an authority to conclude contracts in the name of the enterprise, that enterprise shall be deemed to have a permanent establishment in that State in respect of any activities which that person undertakes for the enterprise, unless the activities of such person are limited to those mentioned in paragraph 4 which, if exercised through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph. Notwithstanding the provisions of paragraphs 1 and 2 but subject to the provisions of paragraph 6, where a person is acting in a Contracting State 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 in the name of the enterprise, or 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, or for the provision of services by that enterprise, that enterprise shall be deemed to have a permanent establishment in that State in respect of any activities which that person undertakes for the enterprise, unless the activities of such person are limited to those mentioned in paragraph 4 which, if exercised through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph.

  11. Agency PE Pre-BEPS • Article 5(5) • Agency PE created if a person (other than an agent of independent status) acting on behalf of a foreign enterprise has ‘authority to conclude contracts in the name of the enterprise’ • Commissionaire arrangements (more common in Europe) were employed to overcome formation of PE under Article 5(5) as goods were sold by an agent in its own name in the other State on behalf of the foreign enterprise, though owned by such enterprise • PE under Article 5(5) was also avoided in situations where contracts though substantially negotiated in one State were finalized/ signed/ authorized abroad • Person habitually exercising authority to conclude contracts constitutes an independent agent in spite of being closely related enterprise

  12. Agency PE Commissionaire Arrangements Commissionaire arrangement Normal arrangement • I Co appointed as “Commissionaire agent”; • I Co does not obtain title to goods, further sells such goods in its own name to customers of Country I • Contract for sale is concluded between F Co and customer thru I Co • I Co is paid commission, which is brought to tax in Country I F Co F Co • F Co sells goods to I Co at ALP • I Co obtains title to goods, further sells such goods to customers of Country I • Profit of I Co is taxed fully in Country I Country F Country F Country I Country I I Co I Co 1 • Commissionaire arrangement may be loosely defined as an arrangement through which 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. Commissionaire generally does not legally bind the principal. 2 • Concept found in civil law countries 3 • India, being a common law country, may not be much impacted by commissionaire arrangements as such structures are not permissible under the provisions of the Indian Contract Act

  13. Agency PE Case Study - Commissionaire Arrangements U Co Supply of goods without transfer of title UK France F Co Sales force Sale of goods

  14. Agency PE Other Similar Strategies 01 03 Contracts substantially negotiated but not concluded in a State; finalization or authorization done abroad Any similar arrangement 02 Person habitually exercising authority to conclude contracts constitutes “independent agent” [as per Article 5(6)] even though closely related

  15. Agency PE Post-BEPS • Agency PE is created under Article 5(5) if a person acting in a Contracting state on behalf of an enterprise either: • Habitually exercises authority to conclude contracts; or habitually concludes contracts [existed before BEPS], or • Habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise [extended scope] • In addition to contracts entered into by the agent in the name of the enterprise, following contracts are also included: • Contracts for provision of services by foreign enterprise • Contracts for the transfer of the ownership of property owned by foreign enterprise, or • Contracts for the granting of the right to use property in respect of which foreign enterprise has the right to use Agent with contract concluding authority has been expanded to cover an agent who concludes contracts or habitually plays the principal role in concluding contracts.

  16. Agency PE Post-BEPS # India has reserved the right for not including the word “routinely” in paragraph 5 of Article 5. (this conflicts with India’s position under MLI)

  17. Agency PE Meaning of the phrase“habitually concludes contracts” • Test of ‘conclusion of contract’ determined based on relevant contract law • If acceptance of offer results in contract by third party under relevant contract law, contract is concluded even if signed outside of source state • Person negotiating all elements and details of a contract in a source state to bind Foreign Enterprise leads to contract conclusion even if signature is by another person outside source state

  18. Agency PE Meaning of the phrase ‘habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise’ • Phrase to be interpreted in the light of the object and purpose of paragraph 5 (i.e. to cover cases where a person acts as the sales force of the enterprise even though, under the relevant law, the contract is not concluded by that person in that State) 01 • Phrase “principal role leading to the conclusion of the contract” will therefore typically be associated with the actions of the person who convinced the third party to enter into a contract with the enterprise. 02 Activities that are not included Advertising of goods and services Marketing and promotion of goods and services which does not directly result in conclusion of contracts Actions sought to be covered Convincing prospective customers Soliciting and receiving orders Forwarding orders which is routinely approved by foreign enterprise

  19. Agency PE Low Risk Distributor (LRD) • LRD concludes contracts on its own behalf; obtains ownership in goods / services from another enterprise and assumes limited inventory risk • LRD (irrespective of whether it is an associated enterprise or not) has been specifically excluded from the ambit of Agency PE • India does not agree with the above interpretation because it considers that distribution of goods owned by an enterprise, associated or related enterprise may create PE, particularly in a case where the risks are not borne by such distributor Other Points • Contracts “in the name of” does not literally mean in the name of the enterprise and would cover situation where name is undisclosed in a written contract • For PE to trigger, activity needs to be done “habitually” • Scope of “habitually” same as existing commentary - reiterates that it is something more than mere transitory • Need to be tested based on facts of each case; No precise frequency test possible • Contracts should relate to the business operations of the foreign enterprise and not for administrative purposes. For instance, authority to hire employees.

  20. Illustration – Conclusion of contracts (1/2) RCO Facts • R Co is a global distributor of goods and services through its website • Employees of S Co facilitate sales of R Co in Country S • Identify potential customers • Use relationship building skills to understand need of customers • Convince them to buy the products/ services offered by F Co through emails, meetings / visits • Responsible for large accounts • Explain standard terms (viz. fixed price, quantity, mode of concluding contracts online etc.) • S Co’s employees cannot modify price structure and contractual terms • Contracts are concluded online between R Co and customers basis price structure presented and discussed • Is there a PE exposure? Online sale of goods Service Fees State R State S Facilitation of sales without formal conclusion of contracts SCO (WOS of RCO)

  21. Illustration – Conclusion of contracts (2/2) RCO Analysis • Employees play a principal role leading to the conclusion of the contract • Inability of S Co’s employees to vary the contract terms not a relevant factor • Presence of non-alterable standard terms do not impact that the contracts were as a result of performance by S Co employees to convince the customers to accept the terms • Role of S Co’s employees – crucial element to conclusion of contract • Triggers dependent agent PE of R Co in State S Online sale of goods Service Fees State R State S Facilitation of sales without formal conclusion of contracts SCO (WOS of RCO)

  22. Agency PE Scope of ‘Authority to Conclude Contracts’

  23. Agency PE Analysis from India Perspective Commissionaire arrangement may not be relevant for India since India is a common law country Indian tax treaties have wide agency PE rule which covers the following: Securing orders Maintenance of stock Delivery Changes could impact foreign companies having subsidiaries in India which undertake marketing and sales support activities Tax authorities may take aggressive views on role played by agents vis-à-vis negotiations of contracts/ securing contracts Maintaining robust documentation on the roles and responsibilities,; detailed mapping of activities of agent and principal in relation to the generation of Indian sales would be critical.

  24. Agency PE Analysis from India Perspective Meaning of ‘Securing order’ Securing of orders may be understood in: Its ordinary meaning wherein activities that result in ensuring that the foreign enterprise gets an order for sale or supply of goods or A wider sense to include solicitation of orders • For instance, in India-USA DTAA, scope of securing of orders is restricted; A person shall be considered to habitually secure order wholly/almost wholly for NR only if: • Such person frequently accepts orders on behalf of NR • Such person habitually represents to the purchasers that its acceptance to the supply order tantamounts to NR acceptance of supply • Actions of NR give reasonable belief to purchasers that the person has authority to bind the NR

  25. Agency PE Analysis from India Perspective Guidance on ‘Securing order’ Most of the Indian tax treaties have generic ‘securing order’ rule; Such tax treaties may not get impacted For Indian tax treaties based on OECD model, substance based analysis would be important Extracts from OECD Commentary “The phrase “habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise” therefore applies where, for example, a person solicits and receives (but does not formally finalize) orders which are sent directly to a warehouse from which goods belonging to the enterprise are delivered and where the enterprise routinely approves these transactions”

  26. Impact - Operation of Liaison office (1/2) Business model R Co. • Permitted activities for a LO in India contained in FEMA regulations • Ratio laid down in Court rulings* in relation to the issue of whether LO in India constitutes a PE of the foreign enterprise in India • Permissible activities • Supply of information • Acting as a communication channel • Doing preliminary and preparatory work • Advertising • Facilitating meetings, arranging stay and travel arrangements etc. • Non permissible activities • Negotiating prices • Pursuing customers • Whether BEPS AP 7 has any impact ? State R State S LO Sale of goods Sales & Marketing Customer * Favourable rulings- IAC v Mitsui & Co. Ltd. [1991] 39 ITD 59 (Del)(SB), Sumitomo Corporation v DCIT [2007] 110 TTJ 302 (Mum), Visakhapatnam Port Trust [1983] 144 ITR 146 (AP), Motorola Inc. v DCIT [2005] 95 ITD 269 (Del) (SB), Airports Authority of India [2008] 299 ITR 102 (AAR)K.T. Corporation [2009] 224 CTR 234 (AAR) Unfavourable rulings- Jebon Corporation 2011-TII-15-HC-KAR-INTL, Rolls Royce PLC v DDIT [2008] 113 TTJ 446 (Del) [ as affirmed in Rolls Royce PLC v DIT [2011] 339 ITR 147 (Del)]

  27. Impact - Operation of Liaison office (2/2) Analysis R Co. • Court rulings in the past have already held if the LO is engaged in activities (eg. Negotiating with customers, convincing, persuading etc.) it would result in creation of a PE in India • Amendment in Article 5(5) will now reinforce the ratio laid down in these rulings State R State S LO Sale of goods Sales & Marketing Customer LO would constitute PE in India, if it habitually plays the principal role in concluding contracts or attracts anti-fragmentation rule, if sales are undertaken in India

  28. Impact - Marketing support service providers (1/2) Business model R Co. • Presence set up in India in the form of a subsidiary to carry out marketing support services (as opposed to setting up a liaison office) State R State S Subsidiary Sale of goods Sales & Marketing Customer

  29. Impact - Marketing support service providers (2/2) Analysis R Co. • Fine line of demarcation between providing support to the foreign enterprise and playing the principal role in concluding contracts • Activities that would trigger a high risk to PE exposure (illustrative list): • Actively pursuing customers to solicit orders • Persuading/ convincing customers to provide orders • Direct nexus between efforts and orders obtained • Verbal contract (eg. Acceptance of offer to enter into a contract with customers or holding out to have that authority( although contract may be signed outside India) • Permissible activities (illustrative list): • Advertising and promotional activities in respect of products • Conducting market research • Collecting feedback from customers and providing to foreign enterprise State R State S Subsidiary Sale of goods Sales & Marketing Customer Subsidiary would constitute PE in India if it habitually plays the principal role in concluding contracts or attracts anti-fragmentation rule if sales is undertaken in India

  30. Article 5(6) of OECD MC Pre BEPS Post BEPS An enterprise shall not be deemed to have a permanent establishment in a Contracting State merely because it carries on business in that State through a broker, general commission agent or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business. Paragraph 5 shall not apply where the person acting in a Contracting State on behalf of an enterprise of the other Contracting State carries on business in the first-mentioned State as an independent agent and acts for the enterprise in the ordinary course of that business. Where, however, a person acts exclusively or almost exclusively on behalf of one or more enterprises to which it is closely related, that person shall not be considered to be an independent agent within the meaning of this paragraph with respect to any such enterprise. For the purposes of this Article, a person is closely related to an enterprise if, based on all the relevant facts and circumstances, one has control of the other or both are under the control of the same persons or enterprises. In any case, a person shall be considered to be closely related to an enterprise if one possesses directly or indirectly more than 50 per cent of the beneficial interest in the other (or, in the case of a company, more than 50 per cent of the aggregate vote and value of the company’s shares or of the beneficial equity interest in the company) or if another person possesses directly or indirectly more than 50 per cent of the beneficial interest (or, in the case of a company, more than 50 per cent of the aggregate vote and value of the company’s shares or of the beneficial equity interest in the company) in the person and the enterprise.

  31. Independent Agent Pre BEPS Article 5(6) Article 5(5) did not apply if the business of the foreign enterprise was carried on in the other state by a broker, general commission agent or any other agent of independent status. Post BEPS • Article 5(6) • Article 5(5) shall not apply if the business of the foreign enterprise is carried on in the other state by independent agent acting in the ordinary course of business • Person qualifies as independent agent if the following conditions are cumulatively satisfied: • Acts in ordinary course of business • Does not act exclusively or almost exclusively on behalf of one or more enterprises to which it is closely related • A person will be closely related to an enterprise [“CRE”] if : • One enterprise possesses directly or indirectly more than 50 percent of the beneficial interest / 50 per cent of the aggregate vote and value of the company’s shares in the other; or • If another person possesses directly or indirectly more than 50 per cent of the beneficial interest in the person and the enterprise • Article 5(6) does not apply where person acts on behalf of NR as an employee or partner

  32. Independent Agent Meaning of certain terms

  33. Independent Agent Holding Subsidiary Relationship • Holding-subsidiary relationship is not sufficient in itself to conclude dependent agent • Even subsidiary should fulfill independence test at par with any entity • If a subsidiary acts on behalf of its parent company in such a way that the parent will be deemed to have a PE under Article 5(5); a subsidiary acting exclusively or almost exclusively for its parent may be regarded as dependent agent • India’s Position on Article 5(6) and commentary • India reserved the right not to include the words “to which it is closely related” in Article 5(6). [This conflicts with India’s position on MLI] • India has reserved the right to make it clear that an agent whose activities are conducted wholly or almost wholly on behalf of a single enterprise will not be considered an agent of an independent status.

  34. Agency PE • Treaties with many countries (for instance US, UK, Canada, Singapore, Mauritius, France, China) contain conditions similar to BEPS for independent agent • Some treaties (US, Canada, France, Netherlands) further impose additional arm’s length condition for it. It is summarized as under: • Extracts of tax treaties Independent Agency Rule under Indian DTAA’s

  35. Amendment to Agency PE clause Implementation of Article 5(5) and 5(6) of OECD through Article 12 of MLI Recent tax treaty negotiations / amendments by India: • Negotiated tax treaty with Hong Kong; Amendments to India Kazakhstan and India Kenya tax treaties • BEPS provision of Agency PE not adopted in the recent treaty negotiations / amendments with above mentioned countries

  36. Article 5(4) Specific activity exemptions

  37. Article 5(4) of OECD MC Pre BEPS Post BEPS 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; the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery; the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise; the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise; the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character; the maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs a) to e), provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character. • 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; • the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery; • the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise; • the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise; • the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity • the maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs a) to e), • provided that such activity or, in the case of subparagraph f), the overall activity of the fixed place of business, is of a preparatory or auxiliary character.

  38. Article 5(4) – Specific activity exemptions Pre BEPS • Article 5(4) of OECD Model Convention • Article 5(4) contains list of business activities treated as exceptions to general PE definition • To qualify for the exemption, place of business should be used only to carry out specified activities mentioned in Article 5(4) • Rationale for the exclusion in Article 5(4) – listed exceptions consist of activities that are very remote from actual realization of profits although these activities may contribute to enterprise productivity • Common feature of the activities listed in Article 5(4) – Such activities were in general preparatory and auxiliary in nature • ‘Preparatory and auxiliary activities’ condition explicitly included only in sub-paras (e) and (f) • OECD Concern: Specific activity exemption open to BEPS abuse specially where such activities are core functions or cohesive business activities are artificially fragmented Preparatory activity : An activity carried out in contemplation of carrying on an essential and significant part of activity of enterprise as a whole Auxiliary activity : Activity carried on to support without being part of the essential and significant part of activity of enterprise as a whole

  39. Article 5(4) – Specific activity exemptions • Existing Article 5(4) • Activities mentioned at sub-paras (a) to (d) are not subject to the condition that activities should be preparatory or auxiliary • Amended Article 5(4) • All activities listed under Article 5(4) would need to be ‘preparatory and auxiliary’ in nature to qualify for exemption under Article 5(4) Key Amendment

  40. Article 5(4) – Specific activity exemptions Illustrations of preparatory and auxiliary activities in Action 7 the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise a) the maintenance of stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery b) Illustrations where PE shall be constituted • Maintaining a large warehouse for storage and delivery of goods sold online; large number of employees work in the warehouse and the warehouse is an important asset of the enterpriseStorage and delivery activities performed through the warehouse, which represents an important asset and requires number of employees, constitutes an essential part of the sale/distribution business. Therefore, such activities do not have a preparatory or auxiliary character • Delivery of spare parts to customers for machinery as well as maintenance / repairs of such machineryThis activity would go beyond the pure delivery and form part of after-sales service which is an essential and significant activity of the enterprise vis-à-vis the customers

  41. Article 5(4) – Specific activity exemptions Illustrations of preparatory and auxiliary activities in Action 7 the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise a) the maintenance of stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery b) Illustrations where PE shall not be constituted • Bonded warehouse with special gas facilities that an exporter of fruit from one state maintains in another state solely for the purpose of storing in a controlled environment during the custom clearance process • Delivery of spare parts to customers for machinery sold to those customers. Fixed place of business maintained solely for the said purpose. Illustrations where PE may be constituted • Enterprise allowed unlimited access to a separate part of warehouse of third party for the purpose of inspecting and maintaining the goods or merchandise stored therein. Since disposal test is met, para b would be relevant. Existence of PE shall depend on whether the activities constitute preparatory or auxiliary activity. Whether activities of storage, display or delivery is preliminary and auxiliary in nature should be determined in light of various factors having regard to overall business activities The above para are irrelevant if the facilities where goods stored is not at the disposal of F Co

  42. Illustration - E-commerce companies (1/2) Business model R Co (E-commerce operator) • Typical business model for E-commerce companies is that customers purchase goods from an online portal • Stock of goods are stored at a warehouse engaging significant personnel for storage and delivery of goods • Goods are delivered to customers pursuant to online sale of goods • Whether R Co has a PE in India ? Sale of goods State R State S Places order online Customer Large Warehouse Delivery of goods

  43. Illustration - E-commerce companies (2/2) Analysis R Co (E-commerce operator) • Preparatory and auxiliary condition’ attached to each of the business activities listed in Article 5(4) • Storage and delivery function may not qualify as ‘preparatory and auxiliary’ in the above factual matrix • Storage and delivery functions performed through the warehouse which represents an important asset and requires large number of employees would be considered an essential part of enterprise’s sale and distribution business Sale of goods State R State S Places order online Customer Large Warehouse Delivery of goods Storage & delivery not preparatory and auxiliary for e-commerce companies. May also extend to non-online sales through warehouse

  44. Illustration - Toll Manufacturing (1/2) Business model R Co (owner of RM/Semi FG) • Arrangementin which a company (which has a specialized equipment and workforce) processes raw materials or semi-finished goods for another company • Raw materials/semi-finished goods are supplied by the principal to the toll manufacturer • Principal remains the owner of the raw materials/semi-finished goods • After processing, the final product is either sent back to the principal or sold to third party on behalf of the principal • Toll manufacturer receives a fee for his services State R State S Final Product (after processing) Supply of RM/Semi FG Customers (Third Party) S Co (Toll Manufacturer) Final Product (after processing)

  45. Illustration - Toll Manufacturing (2/2) Analysis R Co (owner of RM/Semi FG) • R Co has no fixed place at its disposal – test of disposition not satisfied - No PE in State S • If R Co is allowed unlimited access to separate parts of facilities (inspection etc), it needs to be examined whether it would fall under Pep & Aux activities • If R Co acts as a distributor of products of other enterprises; The activity of mere maintenance of stock of goods belonging to an enterprise for processing by another enterprise would not form an essential and significant part of the activity of the distributor. State R State S Final Product (after processing) Supply of RM/Semi FG Customers (Third Party) S Co (Toll Manufacturer) Final Product (after processing) What if R Co is a manufacturer ? Enterprises may need to review the need to shift from a toll manufacturing model to a contract manufacturing model.

  46. Article 5(4) – Specific activity exemptions Illustrations of preparatory and auxiliary activities in Action 7 the maintenance of fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise. d) Purchase Function Illustrations where PE shall be constituted • F Co, a trader of particular product produced in State S, [which it sells from State R to distributors situated in different countries], maintains a purchasing office in State S • Employees working in office at State S are experienced and visit producers in that state, determine the type/ quality of the products according to international standards and enter into different types of contracts (spot or forward) for the acquisition of products by F Co. • Exception of para d shall not apply because the purchasing function forms an essential and significant part of F Co’s overall activity. Illustrations where PE shall not be constituted • F Co operates a number of large stores, maintains an office in State S during a two-year period for the purpose of researching the local market and lobbying the government that would enable it to establish stores in State S. During that period, employees of F Co occasionally purchase supplies for their office. Overall activity preparatory in nature.

  47. Article 5(4) – Specific activity exemptions Illustrations of preparatory and auxiliary activities in Action 7 the maintenance of fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise. d) Purchase Function (contd.) Position under Indian domestic law • As per Explanation 1 to Section 9(1)(i), no income shall be deemed to accrue or arise in India through or from operations which are confined to the purchase of goods in India for the purpose of export Discussion Points • Substantive change to the scope of purchase function • Impact of amendments in light of domestic provisions • Whether purchase by manufacturers on regular basis be affected ? • Whether functions of LOs engaged in purchasing activities requires evaluation ?

  48. Article 5(4) – Specific activity exemptions Illustrations of preparatory and auxiliary activities in Action 7 the maintenance of fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise d) Collection of information Illustrations where PE shall not be constituted • An investment fund sets up an office in a State solely to collect information on possible investment opportunities in that State • An insurance enterprise that sets up an office solely for the collection of information, such as statistics, on risks in a particular market” • Newspaper bureau set up in a State solely to collect information on possible news stories without engaging in any advertising activities” Illustrations where PE shall be constituted • Where a fixed place of business which is used for the supply of information, not only gives information but also furnishes plans etc. specially developed for the purposes of the individual customer Relevant and necessary to determine whether collection of information goes beyond the preparatory or auxiliary threshold

  49. Article 5(4) – Specific activity exemptions Illustrations of preparatory and auxiliary activities in Action 7 Activities not expressly listed in (a) to (d) as long as that activity has preparatory or auxiliary character [Other Activities] d) Illustrations where PE shall be constituted • Management office set up to manage the entire or part of an enterprise. The function of managing an enterprise wholly / partly, constitutes an essential part of the business operations of the enterprise Illustrations where PE shall not be constituted • Training employees at one place before these employees are sent to work at remote work sites located in other countries, the training that takes place at the first location constitutes a preparatory activity for that enterprise. • Scientific research (no manufacture involved)* • Sale of merchandise, which was displayed at a fair/convention, at the end of the fair/convention *Scientific research is explicitly covered in exclusion under Article 5(4) in certain tax treaties e.g. India-Switzerland tax treaty

  50. Article 5(4.1) Anti - fragmentation rule

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