ey africa tax conference - united · pdf filepage 2 panel justin liebenberg international tax...

Permanent establishments risk in Africa

EY Africa Tax Conference

September 2014

Panel

Justin Liebenberg

International Tax

EY South Africa

Panel Charles Makola

International Tax

EY South Africa

Chinyere Ike

EY Nigeria

Moderator

Christopher Kirathe EY Kenya

Josephine Banda

EY Botswana


Agenda

► Global focus on PEs is increasing

► General PE and Global perspective

► Provision of services

► Business travelers or seconded employees

► Sales through agents and commissionaires

► Arrangements involving sub-contractors

► Construction assembly or installation projects

► Toll or contract manufacturing arrangements

► Other

► Way forward


Tax risk and controversy survey

EY 2014 Tax risk and controversy survey

► Reputation risk

► BEPS and legislative risk

► Enforcement risk

► Operational risk


EY presence in Africa

EY office

No EY office, but support available


EY office

No EY office, but support available

General PE and global perspective


Permanent Establishment (PE)

► Art. 7(1) of the OECD and UN Model Conventions

► “The business profits of an enterprise of a Contracting State shall be taxable only in that

State unless the enterprise carries on business in the other Contracting State through a

permanent establishment situated therein.”

► Art. 5(1) of the OECD and UN Model Conventions

► “... a fixed place of business through which the business of an enterprise is wholly or partly

carried on.”

► OECD and UN Model Convention Commentaries on Art. 5(1)

► Three requirements for the existence of a PE

1. Fixed

2. Place of business

3. Business carried on through that fixed place of business


The PE concept

► Basic rule – a fixed place of business through which the business of the Foreign Enterprise(FE) is

wholly or partly carried on

► Construction rule – a building site, construction or installation project which exceeds 12 months

► Agency rule – dependent agents having authority to habitually conclude contracts

► Services rule – option provided to countries to include the rule in 2010 update

► Exclusion for certain activities which have a

preparatory or auxiliary character

► Fixed place used for storage, display, delivery of

goods, fixed place used for purchase of goods

and collection of information

► Subsidiary, per se, not a PE unless it satisfies

any of the specified rules

Exclusion Subsidiary

Structure of PE rule under OECD MC


The PE concept


Key deviations in UN MC

UN Model Convention

(UN MC)

► Greater emphasis on Source State taxation

► Lower activity threshold for constituting PE

► Additional rule relating to “Services PE”

► Construction PE threshold reduced to 6 months

► Additional rule to cover dependent agent maintaining stock of goods for

delivery

► Preparatory or auxiliary exclusion restricted to use of fixed place for storage or

display

OECD developments

► OECD revised discussion draft on PE (published in October 2012):

► Potential broadening of the PE concept

► Interpretation of “at the disposal”

► PE through use of subcontractors – an enterprise can carry on business activities in another

state, even where such activities are carried on entirely or partly through a subcontractor

► Proposals not reflected in 2014 update of the OECD Model Tax Convention(OECD MC)

► BEPS Action Plan:

► Action 7 – proposes to develop changes to the definition of PE to prevent the artificial

avoidance of PE status in relation to BEPS, including through the use of commissionaire

arrangements and under the exceptions for preparatory and ancillary activities – target date:

September 2015

► G20 Development Working Group on the Impact of BEPS in Low Income Countries, July 2014


What is the relevance of changes to the OECD or UN Commentary?


How to read PE survey results

Beware!

Looks “okay”, but the light may change

The “in-betweens”


EY PE Survey conducted by EY South Africa Office, 2013

PE survey results Static vs dynamic approach

Botswana

Ghana

Kenya

Mauritius

Mozambique

Namibia

Nigeria

South Africa

Tanzania

Austria

Belgium

Canada

Finland

Germany

Greece

Norway

Turkey

UK

Africa Rest of the world

Dynamic

Static

Unclear



Arrangements that frequently give rise to PE challenges

Bases for permanent establishment assertions (global parent companies)

Provision of services 57%

Sales through agents and commissionaires 31%

Business travelers or seconded employees 25%

Arrangements involving sub-contractors 16%

Construction assembly or installation projects 24%

Toll or contract manufacturing arrangements 8%

Other 11%


Services PEs Which situations?

Country A Country B

“Fly-in”

consultant


Services under the OECD Model Optional provision

OECD commentary – paragaph 42.23 (optional provision) Notwithstanding the provisions of paragraphs 1, 2 and 3, where an enterprise of a contracting state performs

services in the other contracting state:

a) Through an individual who is present in that other state for a period or periods exceeding in the

aggregate 183 days in any twelve month period, and more than 50 per cent of the gross revenues

attributable to active business activities of the enterprise during this period or periods are derived from

the services performed in that other state through that individual.

Or

b) For a period or periods exceeding in the aggregate 183 days in any 12 month period, and these services

are performed for the same project or for connected projects through one or more individuals who are

present and performing such services in that other state

the activities carried on in that other state in performing these services shall be deemed to be carried on

through a permanent establishment of the enterprise situated in that other state.


Subcontracting of services OECD vs UN – any differences?

Country A

Country B

Company A Company B

Subcontracting

agreement

Customer

Services PE? ► OECD: subcontracting explicitly carved out, unless subcontractor’s personnel is supervised, controlled or given

directions by the main contractor

► UN: no such explicit provision; reference to furnishing of services by “employees or other personnel”

140 days 60 days


Statistics Services PEs in recent tax treaties

Scope:

1,586 tax treaties concluded between 1 January 1997 and 1 January 2011

Treaties between

two UN countries

Treaties between

a UN and OECD

country

Treaties between

two OECD

countries

Total

UN model

services

provision

57.74%

(399 of 691)

34.87%

(242 of 694)

14.92%

(30 of 201)

42.3%

(671 of 1,586)

Optional OECD

services

provision

0.00%

(0 of 691)

0.58%

(4 of 694)

2.48%

(5 of 201)

0.57%

(9 of 1,586)

Source: Bulletin for International Taxation, 1/2012










Other 11%


The discussion draft Dependent agent PEs (commissionaire)

► The working party has failed to reach a common conclusion on the Zimmer

and (lower court) Dell cases

► However, the discussion draft proposes to add a new example to Para. 32.1

of the commentary on Art. 5, which provides that:

“[…] in some countries an enterprise would be bound, in certain cases, by a contract concluded

with a third party by a person acting on behalf of the enterprise, even if the person did not formally

disclose that it was acting for the enterprise and the name of the enterprise was not referred to in

the contract.”

► Norwegian Supreme Court decision on Dell (2 December 2011):

► Commissionaire (i.e., Dell Norway) does not constitute a PE of Dell Ireland in Norway

► Contracts concluded by Dell Norway were not legally binding on Dell Ireland

► Decision in line with the Zimmer case


Example Contract manufacturers and dependent agent PEs (DSM, Spain, 2008)


► DSM Switzerland and Roche Spain entered into

a contract manufacturing and marketing and

promotion agreement

► Roche Spain produces to order, based on

instructions of DSM Switzerland

► DSM Switzerland leases from Roche Spain a

small warehouse for temporary storage of goods

DSM

Switzerland Supplies goods and

performs marketing

functions, but no authority

to conclude contracts

Roche Spain

Findings of the Spanish National Court: ► Fixed place of business (warehouse), but no PE of itself, as storage is treated as an auxiliary activity

► No “authority to conclude contracts” under the marketing and promotion agreement, and thus no dependent agent

PE under that agreement alone

► But DSM Switzerland had a dependent agent PE under the contract manufacturing agreement: “The dependent

agent clause operates not just when the agent has the authority to contract in the name of the foreign principal,

but also when, given the nature of the activity, the agent involves the principal in the business activities of the

domestic market”.

Determines

quantities,

design, etc.


What is the risk of PE creation under a commissionaire arrangement (fact pattern similar to Zimmer)?

PE survey results Commissionaire

Botswana

Ghana

Kenya

Mauritius

Mozambique

Namibia

Nigeria

South Africa

Tanzania

Austria

Belgium

Denmark

Finland

Germany

Greece

Norway

Turkey

Spain


High

Low

Medium



Commission arrangement

► Commission arrangement in terms of which

the agent renders services to principal for

arms length commission

► The customer deals directly with the

principal in respect of the supply of goods

or services

► Whether the agent creates a PE tax

presence for the principal


Principal Agent

Goods or

services Customer

Commission payment

Invoice for commission

Supply

Commissionaire arrangement

► Commissionaire arrangement in terms of

which the agent invoices in its own name

on behalf of undisclosed principal

► Commissionaire earns arm’s length

commission

► Commissionaire cannot conclude

contracts on behalf of the principal

► Whether the agent creates a PE tax

presence for the principal:

► South Africa

► Kenya

► Ghana

► Botswana


Principal Agent

Goods or

services Customer

Invoice and commission

Remit payment for supply

Supply

Invoic

e f

or

supply

Initia

l in

quiry a

nd

paym

ent

for

supply









Other 11%


Potential compliance

Items to consider in assessing PE exposure

► Seconded employees vs business travelers

► Relevant questions for business travelers (“fly-in workers”)

► Whose business is carried on?

► What is worker exactly doing?

► How often does worker travel?

► How long does worker stay each time?

► Does worker have office and space at disposal?

► Activities of the foreign enterprise to be analyzed as a whole

► Which PE provision may come into play?

► Fixed place PE?

► Services PE?

► Other?

► Relevance of TP arrangements:

► Relevance of “significant people functions” carried on by seconded personnel

Registration as

taxpayer

File a tax return

DTA protection and

profit attribution

Withholding tax on

services


Employee secondment

Arrangement Typical options

Option 1 The employee remains formally employed

by Company A, but he or she actually

performs the business activities of

Company B, which is considered his or her

“economic employer”.

Option 2 The employee carries on the business

activities of Company A, and Company B

is not considered to be his or her

“economic employer”.

Company B

Secondment of

employees

Salary payment to

bank account of

employee

Reimbursement of cost

Company A

Questions:

► Would the employee create a PE for Company A under option 1

► Would the employee create a PE for Company A under option 2


OECD discussion draft Foreign employee secondments and PE creation risks

► The OECD discussion draft seeks to align the commentary on PEs with the

2010 changes to the commentary on employment incomes (Art. 15):

► Changes to the commentary on Art. 15 clarify that the formal employment relationship with

the nonresident employer can, in certain circumstances, be disregarded, e.g., if it is

established that the services performed by a nonresident employee are “economically”

performed in an employment relationship with the local enterprise.

► Implications for the PE analysis:

► Where it is established that the nonresident employee is “economically” employed by a

local enterprise, that employee should not be deemed to be carrying on in the other

contracting state the business of his formal non-resident employer that could result in the

creation of a PE (see option 1).

► Where that employment relationship is not to be disregarded, the foreign enterprise is still

considered to be carrying on business activities in the other contracting state through its

employees, and that could potentially result in the creation of a PE (see option 2).










Other 11%


OECD discussion draft Contractor who subcontracts all business activities

► An enterprise can carry on business activities in another state, even where

such activities are carried on entirely or partly through subcontractors.

► In that case, a permanent establishment may be found to exist if the

conditions under Art. 5 are met:

► Subcontractors must perform the work of the enterprise at a fixed place of business that

is at the disposal of the enterprise for reasons other than the mere fact that these

subcontractors perform such work at that location

► The “small hotel” is a good example of this


Subcontracting The small hotel example

► Company A owns the hotel.

► Company A rents out hotel rooms

through the internet.

► On-site operation of the hotel is

subcontracted to Company B.

► Company B is remunerated on a cost-

plus basis.

Company A Company B

Internet

sales

Unrelated customers

Country B

On-site operation of

the hotel

Country A

Subcontracting

agreement

Fixed place of business at the disposal of the enterprise?

“A location is at the disposal where the non-resident’s enterprise has an exclusive legal right to use that

location and the location is used exclusively for its business.”

Small hotel


Example – offshore accomodation Service AB vs Government of Norway (2001)

► Rostrum entered into a management

agreement with the lessee of a rig in the North

Sea (Norwegian continental shelf).

► Rostrum concluded an agreement with

Offshore accommodation regarding the

provision of catering services on the rig.

► Offshore accommodation did not itself provide

catering services on the rig, but concluded an

agreement with Chalk Catering, a Norwegian

company.

► Under this agreement, Chalk Catering

physically provided catering on the rig.

Brostrom

Court’s findings:

► Offshore accommodation had a PE in Norway:

► Under the relevant treaty, any offshore activity carried on for 30 days or more constitutes a PE.

► Although offshore accommodation did not physically perform the services, it was responsible to Rostrum for the quality of services,

and was deemed to carry on business.

► The Court relied on the OECD Commentary on construction PEs (see Para.19 (Art. 5)).

Chalk Catering

Management agreement with the

lessee of the rig

Offshore

accomodation

Agreement regarding catering on

the rig

Agreement on provision of

catering services on the rig

Sweden Norway

Physical performance of

catering services on the rig

1

2

3

4

Rig


Where a foreign enterprise operates in your jurisdiction exclusively through subcontractors, would it be considered to be carrying on business in your jurisdiction?


PE survey results Sub-contracting

Botswana

Ghana

Kenya

Mauritius

Mozambique

Namibia

Nigeria

South Africa

Tanzania

Australia

Belgium

Canada

Finland

Germany

Greece

Norway

Turkey

UK


Yes

No

Unclear











Other 11%


Would the tax authorities and courts in your jurisdiction accept that there is no construction PE where the time test is not met, regardless of whether or not the construction site would constitute a fixed place?


PE survey results Construction and project PEs vs fixed place PE

Botswana

Ghana

Kenya

Mauritius

Mozambique

Namibia

Nigeria

South Africa

Tanzania

Australia

Belgium

Canada

Finland

Germany

Greece

Norway

Turkey

UK


Yes

No

Unclear











Other 11%


Business restructuring

► Business restructuring (supply chain reorganizations)

responds to market needs and increased competition.

► Typical business restructuring would involve the

redeployment of functions, assets and risks within

group entities.

► For example, reducing the functional significance of an

entity in a particular jurisdiction, while increasing the

commercial importance of a group entity in another

jurisdiction.

► This normally results in a reduced profit potential in a

particular jurisdiction with an impact on future

profitability.

► Examples:

► Conversion of a full-fledged manufacturer into a toll or

contract manufacturer

► Conversion of a full-fledged distributor into a limited risk

distributor or commissionaire


Operating sub-

manufacturing

distributor

Swiss parent

Customers

Supply of goods Manufacturing

Payment for goods

ROI 100%

Restructuring case study

► After restructuring, the Swiss parent entered into two

contracts with the operating sub-manufacturing

distributor:

► Manufacturing agreement – manufacturing under strict

instructions from the Swiss Principal

► Sales promotion agreement, including lease of warehouse

to the Swiss principal

► Swiss parent sets sales prices and invoices to

customers

► The Swiss parent directly sells the goods manufactured

by operating sub to customers

► Operating sub management reports to the Swiss

parent, which has authority to issue directives

► Operating sub management bound by strict internal

governance procedures

► Only limited budgetary responsibility of operating sub

management


Operating sub-

manufacturing

distributor

Swiss parent

Customers

Sale of goods and

invoicing

Manufacturing

Payment for goods Manufacturing

and sales

agreement

Delivery of goods

Restructuring PE creation risk

► Fixed place PE

► Premises of a converted entity constitutes a PE for the foreign principal?

► Principal’s staff sent to oversee production at contract or toll manufacturer’s factory – when

would they constitute a PE for the principal?

► Reliance on exceptions for preparatory or auxiliary activities?

► Dependent agent PE: “authority to conclude contracts in the name of the

enterprise”

► Contract or toll manufacturer involved in sales?

► Limited risk distributor or commissionaire considered to be a dependent agent?

► Delivery agent PE under the UN Model

► Reliance on exceptions for preparatory or auxiliary activities?


Business restructurings and “at the disposal”

► Enterprise’s presence at the location and the activities it performs are key.

► A location that is owned and used by a supplier or a contract manufacturer

not per se at the disposal of the foreign enterprise.

► A certain location is at the disposal of the enterprise where that enterprise

carries on its business activities on a continuous and regular basis at a

location that belongs to another enterprise or is used by several enterprises.

► A location is at the disposal where the nonresident’s enterprise has an

exclusive legal right to use that location and the location is used

exclusively for its business.


Example Analysis of the exceptions under the OECD and UN Models

[…]

b) the maintenance of a stock of goods or merchandise belonging

to the enterprise solely for the purpose of storage, display or

delivery

c) the maintenance of a stock of goods or merchandise belonging

to the enterprise solely for the purpose of processing by

another enterprise

[…]

f) the maintenance of a fixed place of business solely for any

combination of activities mentioned in sub-paragraphs a) to e),

provided that the overall activity resulting from this combination

is of a preparatory or auxiliary character

[…]

b) the maintenance of a stock of goods or merchandise belonging to

the enterprise solely for the purpose of storage or display

c) the maintenance of a stock of goods or merchandise belonging to

the enterprise solely for the purpose of processing by another

enterprise

[…]

f) the maintenance of a fixed place of business solely for any

combination of activities mentioned in sub-paragraphs a) to e),

provided that the overall activity resulting from this combination is

of a preparatory or auxiliary character

OECD Model – Art. 5(4) UN Model – Art. 5(4)


Concept of “delivery” (X Ltd vs APEH, Hungary, 2008)


► Hungarian Supreme Court opinion interpreting the UK-

Hungary double tax treaty

► UK company held a branch in Hungary through which it

sold goods to a related Hungarian company, which then

sold them on to unrelated customers

► UK company argued it was only keeping goods in

Hungary for the purpose of “storage, display and

delivery”

Findings of the Hungarian Supreme Court Held that the UK company had a PE because:

► It resold the goods to another person

► It issued invoices in the name of the Hungarian branch and

► The branch’s corporate registration stated that its activities included the distribution of goods

UK Co

Unrelated

customers

Hungarian

branch

Goods

Goods

Hungarian Co

Goods









Other 11%


Other Time limits


OECD discussion draft Time limits for (fixed place) PE creation

► Six-month period as a general rule applied by most countries

► No changes to commentary proposed in discussion draft

► Exceptions to the six-month rule: ► Recurrent activities

► Business carried on exclusively in the source state – one-shot projects

► Discussion draft proposes to add two examples to illustrate these exceptions

► Implications for special purpose vehicles in general?

► In the context of construction and project PEs?


Would the tax authorities in your jurisdiction consider that the time requirement for the creation of a permanent establishment is met where a business project is wholly carried on in your jurisdiction, although it lasts only for 4 months?


PE survey results One shot projects

Botswana

Ghana

Kenya

Mauritius

Mozambique

Namibia

Nigeria

South Africa

Tanzania

Australia

Belgium

Canada

Finland

Germany

Greece

Norway

Turkey

UK


Yes

No

Unclear



Way forward


Where should taxpayers head from here?

► Planning

► Implementation

► Dispute resolution


Where should taxpayers head from here?


► Review all inbound services performed by foreign companies in order to determine the extent of PE exposure.

► Determine whether the foreign entity has corporate income tax exposure in local countries by virtue of source or other domestic law criterion.

► Establish whether the foreign entity needs to register for income tax and file a tax return in local jurisdiction.

► Review availability of financial data and other information used to compute profit allocations.

Planning Implementation Dispute resolution

► To avoid unpleasant PE surprises, make sure that your facts are aligned with what is happening on the ground.

► Develop high-standard documentation in a wider range of countries than ever.

► Be prepared to rely on other channels of resolution, including those you may not have considered to date, such as Voluntary Disclosure Programme and Settlement.

► Keep in mind the reputational risk that the public debate may generate and engage in a dynamic way with internal and external stakeholders to minimize the possibility of unfavorable outcomes.

Questions


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