FTI Consulting’s response to the draft paper and updates from the public consultation
“The threshold for PEs has now been agreed at a high level [by WP1], but it is paramount to businesses and the tax authorities … to apply that [threshold] consistently [to] what we believe … will be a substantial increase in the number of PEs”Co-Chair, WP6, 11th October 2016.
On 11th October, the OECD held a Public Consultation on the attribution of profits to Permanent Establishments (“PEs”), which was attended by tax authorities, business umbrella organisations and leading tax and accounting firms, including FTI Consulting. In this article we outline FTI Consulting’s response to the draft guidance on profit attribution to PEs, as well as the key takeaways from the Public Consultation meeting.
Changes to PE definition and profit attribution guidance
The Action 7 report on Preventing the Artificial Avoidance of Permanent Establishment Status, published in October 2015, recommended amending the current definition of a PE in Article 5 of the OECD Model Tax Convention. The result of these changes is to expand the definition of a taxable presence of an enterprise in a foreign country through (1) extending the circumstances in which an agency PE would be deemed to exist, (2) limiting the scope of specific exemptions in Article 5(4) of the Model Tax Convention and (3) introducing an anti-fragmentation rule.
The OECD’s view is that although the proposed Action 7 wording will modify the PE threshold, the nature of the PE itself will not change. Therefore, the existing guidance in the Attribution of Profits to Permanent Establishments Report (2010) and the Commentary to Article 7 should be applicable in future without the need for substantial modifications. However, there was recognition that further guidance is needed for the attribution of profit to PEs where the PE definition has been expanded and this was the topic for discussion at the public consultation.
FTI Consulting’s response to the OECD’s profit attribution guidance
The attribution of profits to a PE is one of the most challenging areas of international tax, due to the complexity of the economic and legal concepts involved in
the attribution analysis, such as the identification of significant people functions, the assumption of risk, the economic ownership of assets and apportionment of
capital. Arguably, the most difficult to apply is the mechanism of hypothesising the PE as a separate enterprise, as although it is based in a different country,
from a commercial, business, legal and economic perspective, the PE forms part of the enterprise as a whole and functions as one with the enterprise.
FTI Consulting drew attention to the point that following the lowering of the threshold for the existence of a PE, a large number of very small and newly established businesses are at risk of being “caught” and forced to file nil PE tax returns. The costs involved in the preparation of the analysis may be wholly disproportionate to the tax being collected. Furthermore, the administrative and legal compliance for these PEs is likely to be disproportionately burdensome.
“With the new PE threshold, it is expected that there will be a multitude of PEs arising, often with no, or limited, additional profits attributable to them.”
We argued, therefore, that some type of proportionality test together with legal and administrative compliance simplification measures would be most welcomed in order to reduce the compliance burden on these smaller and newly expanding businesses, especially in cases where the tax at stake is not material.
Furthermore, there is a risk that tax authorities in different countries will not share the same view of the profits attributable to a permanent establishment, potentially leading to more disputes. We urged the OECD to consider an enhanced mechanism for the elimination of double taxation, such as the EU Arbitration Agreement, alongside the filing of a PE return or the issuing of a PE tax assessment.
Public Consultation update
The participants invited to speak at the public consultation discussed a number of topics on profit attribution. FTI Consulting spoke on the order of application of Article 7 and Article 9 analyses in cases where an enterprise has in a foreign jurisdiction both, a dependent agent PE and a dependent agent enterprise. We argued that it would be simpler for the taxpayer to apply Article 9 analysis first, and most commentators agreed with us.
Other parties to the consultation echoed FTI Consulting’s concern about the administrative burden arising from a significant increase of the number of PEs, with very limited or nil profit attributable to them. For these PEs, a practical solution in relation to legal and administrative compliance was widely requested.
There was also considerable discussion over the concept of Significant People Functions and how the description of the concept differs from the notion of risk control under Chapter 1 of the Transfer Pricing Guidelines. Many parties called for more clarity or a mapping of the terms under the various papers such that the intention is clearer.
Also discussed were commissionaire structures, which are expected to create PEs under the new rules. There appears to be a serious concern that companies will be forced to record revenue in the country where a commissionaire PE is found to exist. Modifying the sales of a company has implications beyond corporate tax payable, such as systems considerations and indirect taxes.
“Clear guidance is desirable on profit attribution, in order to reduce the risk of challenges, promote clarity, balance cost vs benefit and simplify compliance.”
At the end of day, the summary from OECD was that there was likely to be significant rewriting of the draft paper before the working party meet again in mid-November. In the redraft the OECD will look holistically at the attribution of profit guidance, considering both Article 7 and Article 9.
Senior Managing Director
+44 (0) 20 3727 1450
November 11, 2016