Tei comments on clarification of PE definition: June 7, 2004.

On June 7, 2004, TEI President Raymond G. Rossi sent the following letter to Jeffrey Owens, Head of the OECD's Centre for Tax Policy and Administration concerning the proposed clarifications of the definition of permanent establishment under the OECD's Model Tax Convention. The comments supplement TEI's October 17, 2003, comments, which were reprinted in the November-December 2003 issue of The Tax Executive.

On behalf of Tax Executives Institute, I am pleased to respond to the request of the Working Party No. 1 on Tax Conventions and Related Questions for comments on proposed clarifications in the Commentary to the OECD Model Tax Convention on some aspects of the permanent establishment (PE) concept, which were published on 12 April 2004, and would specifically include in the Commentary some widely accepted interpretations of the concept held by the business community. This letter supplements TEI's 17 October 2003, comments on the same issue. TEI applauds the Working Party for seeking clarification of the PE definition. For the reasons set forth below, we urge the OECD to move swiftly toward adoption of the recommendations.

Background

Founded in 1944 as a non-profit organization in the United States to serve the professional needs of business tax professionals, TEI now has an international scope with 53 chapters spread throughout North America and Europe. Our 5,400 members represent 2,800 of the largest companies in the United States, Canada, and Europe. TEI represents a cross-section of the business community; it is dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and governments alike. As a professional association, TEI is firmly committed to maintaining tax systems that are administrable and with which taxpayers can comply.

The majority of TEI members work for multinational companies with substantial international operations and sales. Members of TEI are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the various tax laws relating to the operation of business enterprises. Consequently, TEI members have a special interest in the PE definition in the OECD Model Tax Convention on Income and on Capital.

Article 5's Definition Of Permanent Establishment

Article 5 of the Model Treaty defines a "permanent establishment" for tax purposes. Under this article, there are two ways in which an enterprise may be found to have a PE:

* Paragraph 1 establishes a physical presence test by requiring a "fixed place of business through which the business of an enterprise is wholly or partly carried on." This definition is supplemented by paragraphs providing examples of a PE (a "positive list"), excluded activities (a "negative list"), and certain exceptions for building sites or construction projects.

* Paragraph 5 provides that certain agencies may also create a PE but requires that a person be acting on behalf of an enterprise and have--and habitually exercise--in a Contracting State an authority to conclude contracts in the name of the enterprise, with exceptions for certain activities (such as storage facilities) listed in Paragraph 4 of the Model Treaty.

In addition, subsection (e) of Article 5(4) provides a general exception excluding the maintenance of a place of business for activities of a "preparatory or auxiliary" character.

Stated affirmatively, the interaction of Articles 5(1) and 5(5) demonstrates that a Contracting State acquires taxing jurisdiction over a non-resident entity (NRE) only if that enterprise has--

* a fixed place of business caused either by the operation of assets of the NRE located in the Contracting State or the action in that state of individual persons in a paid-employment relationship with the NRE, or

* a dependent agent, which authorizes the persons, individuals, or companies to act for the NRE in the Contracting State.

a. One Specific Enterprise. The Working Party proposes to clarify that "[w]hen applying the permanent establishment definition, one must look at a specific enterprise and not at a group of entities as a whole." Paragraphs 41 and 42 of the Commentary would address the situations in which a parent may be found to have a PE in a State where its subsidiary has a place of business, including having space available in the subsidiary's fixed place of business (FPOB). A parent will also be deemed to have a PE in a State in respect of any activities that its subsidiary undertakes for it if that subsidiary has--and habitually exercises--an authority to conclude contracts in the name of the parent, unless these activities are limited to certain specified actions or "the subsidiary acts in the ordinary course of business as an independent agent to which paragraph 6 of the Article applies." Similar treatment applies (in new paragraph 41.1) as between any two related members of a multinational group of companies. The proposed revision continues that "the existence in one State of a permanent establishment of one company of the group will not have any relevance as to whether another company of the group has itself a permanent establishment in that State."

TEI supports this clarification. The principal definition of a PE set out in Article 5(1) requires a FPOB through which the business of the enterprise is wholly or partly carried on. It is the FPOB of the NRE itself that must exist in the State, not an FPOB of the local entity. Recent court decisions have confused a subsidiary with a branch and this revision would effectively address that confusion.

b. Management Services. The Working Party proposes to clarify that management services provided to an NRE on an arm's-length basis do not create a PE. New paragraph 42 of the Commentary would focus on the important distinction between situations where a foreign enterprise carries on its business through an FPOB and those where a member of a multinational group provides services (such as management services) to another member of the group as part of the first member's own business on its own premises and with its own personnel.

TEI supports this clarification. An FPOB cannot constitute a PE of the NRE unless it is owned, used, or otherwise at the disposal of the NRE and carries out the business of the NRE. Thus, the provision of management services should not constitute a PE of the NRE where a separate local legal entity (such as a subsidiary) that is not placed at the disposal of the NRE performs services for the NRE.

c. Mere Participation in Negotiating Contracts. The Working Party proposes to clarify that mere participation in meetings for the negotiation of contracts will not, in itself, support a decision that the person has exercised an authority to conclude contracts in the name of a foreign enterprise. Paragraph 33 of the Commentary would be revised to state that the mere fact a person has attended "or even participated in" negotiations in a State between an enterprise and a client will be insufficient to conclude that the person has exercised an authority to conclude contracts in the name of the enterprise. This could, however, be a relevant factor in determining the exact functions performed by that person on behalf of the enterprise.

TEI supports this clarification. Under Article 5(5), the existence of the authority to conclude contracts should be the determining factor in whether a PE is found to exist. Such power must be real. We agree that merely being present at the negotiations cannot, in and of itself, be sufficient justification for finding a PE under Paragraph 5.

d. Flow Chart. In our 17th October comments, TEI suggested that the OECD consider using a flow chart to aid interpreters of this important but complex Article. We continue to believe that such a chart would be valuable and attach it again for your consideration.

Conclusion

Tax Executives Institute appreciates this opportunity to present our views on the definition of permanent establishment in the OECD Model Tax Treaty. If you have any questions about the Institute's views, please contact TEI's Executive Director, Timothy J. McCormally, at 1.202.638.5601.

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