Michael Scharf

Phone: +49 (9 11) 91 93 - 10 70
Fax: +49 (9 11) 91 93 - 70 70

Dominika Tyczka

Steuerberaterin (Polen)
Senior Associate
Phone: +48 71 733 97 92

Following the OECD-Report Addressing Base Erosion and Profit Shifting (hereinafter ”BEPS”) of multinational enterprises, the G20 countries have requested the OECD to develop a comprehensive Action Plan to resist BEPS. Based on the OECD Action Plan published in July 2013, effective and internationally coordinated regulations had been developed until the end of 2015 to resist BEPS. On October 5, 2015 the OECD has published the final package of the BEPS Actions and on October 8, 2015 the G20 has approved Action 7. The particular focus of Action 7 is the artificial avoidance of the permanent establishment (hereinafter ”PE”) status by tax-motivated constructions. Currently the OECD is working on the required modifications concerning the profit determination of a PE.
Content of the final report to BEPS Action 7
Action 7 particularly aims to extend the definition of PE in Article 5 of the OECD Model Tax Treaty. Primarily this concerns the adjustment of the definition of agency PEs and building and construction PEs. Furthermore, the OECD tightened the conditions for PE exemptions.
Artificial avoidance of PE status by establishing agency and commissionaire models
According to the current wording in Article 5 paragraph 5 of the OECD Model Tax Treaty, an agency PE status is given, where a person is acting on behalf of a foreign enterprise and has, and habitually exercises, in a Contracting State an authority to conclude contracts in the name of the enterprise. In the frame of BEPS project the OECD noted enterprises frequently misuse the current PE definition and thereby artificially avoid the PE status.. To prevent the artificial avoidance of PE status the OECD suggested a comprehensive modification of the definition of agency PEs in Article 5 paragraph 5 and 6 of the OECD Model Tax Treaty.
According to the modification the authority to conclude agreements shall not longer be considered as a condition for a PE. Furthermore, the requirement that an agent shall act in the name of the principal will be cancelled. To conclude contracts in the meaning of the new definition shall not mean that the agent is required to sign contracts in his own hand, rather a contract is deemed to be concluded when he negotiates the essential elements and details of the contract that become binding for the principal. It is remarkable that the condition for PE establishment is not only the conclusion of contracts, but also when the agent is playing the principal role which is leading to the conclusion of such contracts. Hence, the essential condition is that the agent acts as distribution engine of the principal and induces unrelated to conclude contracts with the principal. Essential contribution of the agent to the contract negotiation on behalf of the principal so that the principal accepts the negotiated conditions without any significant changes shall be sufficient to establish a foreign PE. 
According to the current PE definition the dependency of an agent is a positive condition for the constitution of a PE. Previously an agent is deemed as dependent if the agent sustainably provides business deals for another company and underlies the instructions of the principal. The new definition of dependency was now extended: according to the new approach of the OECD, a person who 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.
From that follows that an agent shall be deemed as a dependent agent if the sales generated for the associated company exceed 90% of agent’s overall sales. For this evaluation only commissioning activities are relevant, activities such as proprietary trading or services are not relevant. The new Article 5 paragraph 6 of the OECD Model Tax Treaty now also contains an own definition for associated enterprises: first of all the enterprises shall be deemed as associated if one enterprise controls the other. 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 of the other enterprise. In view of commissioning third parties who are acting exclusively for one Principal the afore mentioned conditions assumably will not be fulfilled, hence, it can be assumed that commissioning unrelated agents should not result in constituting a PE. However, the majority of intragroup agent- and commissionaire distribution models are structured in a way that the sales agents or commissionaires distribute goods or services exclusively for one related principal. Hence, the exemption of the independent agent should be applicable very rarely in the future.
With regard to the commercial agent constructions the following applies: distribution company A, resident of e.g. Germany concludes with the associated agent B, resident of e.g. Poland, a commercial agent contract. A engages B to distribute goods in the name and account of A. In this case B operates solely on behalf of a principal (A). Based on the distribution contract B agrees an agreement with the client C. The agreement between B and C obliges company A to deliver goods to client C. In such a case the distribution activities of agent B constitute a PE of company A in Poland. Due to the fact that the distribution activities of many groups are constructed in that way the major part of existing agent- and commissionaire distribution models will lead to constitution of PEs. The intention of profit shifting and artificial tax avoidance is not a condition for application of the new agency PE definition. This means in future, that even companies which established agent- and/or commissionaire distribution models due to economic reasons will be affected by the BEPS Action 7.
Revision of the specific exemptions in Article 5 paragraph 4 of the OECD Model Tax Treaty and ”anti-fragmentation-rule”
Article 5 paragraph 4 of the OECD Model Tax Treaty includes a list of exceptions according to which a PE is not deemed to be constituted. Among others, fixed places of business for the purpose of storage, display or delivery of goods or fixed places of business which solely serve for the purpose of purchasing goods or collecting of information shall not be deemed as a PE. A new condition is that the exceptions shall only apply if the listed activities have a preparatory or auxiliary character. Consequently the OECD aims to affirm PEs especially in that countries where value-added activities are performed for a foreign associated enterprise.
In order to prevent abusing constructions in connection with preparatory or auxiliary activities a new section shall be added to paragraph 4 of Article 5 OECD Model Tax Treaty. This section provides that enterprises cannot fragment a cohesive operational activity into several small operations in order to argue that each is merely of a preparatory or auxiliary character (so-called ”anti-fragmentation-rule”). For the purposes to define whether a PE is constituted or not all single activities should be regarded coherently. Should the single activities as a total not be considered as preparatory or auxiliary activities the exemption in Article 5 paragraph 4 of the OECD Model Tax Treaty will not apply.
Moreover, unlike the previous regulation the condition that the activities in question shall be of preparatory or auxiliary character is prefixed to all exemptions. The preparatory or auxiliary activities therefore constitute a clamp function.
Artificial avoidance of the building or construction PE status
The final OECD report relating to Action 7 also contains a new regulation with regard to the artificial avoidance of building and construction PE status by splitting business activities (so-called ”splitting-up contracts”). According to the current regulation in Article 5 paragraph 3 of the OECD Model Tax Treaty building, construction or installation activities constitute a PE only if it lasts more than twelve months. According to OECD some enterprises developed a strategy to avoid the PE status by dividing a cohesive building process into several parts, each lasting less than twelve months. The regulation against ”splitting-up contracts” aims to make the division of cohesive business processes in several parts impossible. The new regulation provides that complementary activities which were performed by a company or a group of related companies shall be considered as one unit of activities in the case the activities are connected to each other. In this regard the new provisions include the requirement that different time periods in which building and construction operations can be based on different contracts but for purposes of definition whether a building site or construction PE status is given the time periods shall be combined.
Summary and Outlook
In practice the amended definition of PE will result in the constitution of foreign PEs besides the foreign subsidiaries with own taxation in most cases where enterprises organize their distribution activities through sales agent and commissionaire models. Furthermore, the amendment of the specific activity exemptions in Article 5 paragraph 4 of the OECD Model Tax Treaty as well as the fragmentation-rule will significantly increase the number of PEs. This will lead to a significant increase of administration efforts, since a separate profit determination with its own accounting needs to be ensured and furthermore, separate tax returns need to be submitted. However, the procedure how to allocate the PE profit is still uncertain. The OECD plans to publish the respective guidelines by the end of 2016. With regard to the profit allocation of PEs the OECD published a discussion draft including an identified questionnaire in July 2016. Until September 5, 2016 there is the possibility to comment it. Therein the OECD refers to regulations in connection with independent agents created by commissioning structures as well as warehouses as a fixed place of business. A public consultation is planned for October 11-12, 2016. The review of the definition of a PE which was published in October 2015 is excluded from potential comments.
The OECD suggestions are not legally binding yet. However, the OECD member states are requested to implement Action 7 into respective bilateral Double Tax Treaties and into domestic legislation promptly. Up to July 2016 a number of 85 OECD member countries have already joined the BEPS project. Our current expectation is that the new regulations will become mandatory as from calendar year 2017.