oil & gas cross border activities - ibfd · 2015-06-30 · •within own territory includes...

Livingstone, Zambia 19 June, 2015

Oil & Gas Cross Border Activities

Eleni KlaverCarrara Legal BV

© 2015 Carrara Legal BV

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AGENDA• Limits on taxing jurisdiction

• Geographical scope

• (Offshore) Exploration and Exploitation

• Sourcing of Income

• Double tax treaties

• Importance of the PE concept

• Construction clauses

• Offshore Clauses

• Treaty characterization of activities

• Business profits

• Royalties, technical service fees

• Services© 2015 Carrara Legal BV

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LIMITS ON TAXING JURISDICTION - Geographical Scope

• Based on International Law Principles:

• Geneva Convention on the Continental Shelf 1958;

• North Seas Continental Shelf Case, ICJ 1969

• UN Convention on the Law of the Sea 1982 (CLS)

• Caution: Pipeline Agreements concluded prior to Convention, e.g. Norpipe Agreement 1972

2 © 2015 Carrara Legal BV

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Zones and Boundaries at Sea:

•Territorial Sea;

•Contiguous Zone;

•Continental shelf;

•Exclusive Economic Zone (EEZ);

•High Seas.



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• Taxing Jurisdiction of a country extends to its territorial waters; EEZ or outer CS if activities connected to “exploration or exploitation of natural resources”;

• Exploration - searching for minerals; Exploitation - extracting minerals;

• All related construction activities;

• FMC Corp & Subsidiaries v. Commissioner, 100 T.C. 595 (1993)

• Design & Engineering;

• Procurement & transport of personnel and materials;

• Gulf Offshore N.S. Limited v. Her Majesty the Queen, Case Number A-217-06

• Diving support, ROV, submersible & semi-submersible devices;

• Ocean Drilling & Exploration Co. v. United States, 24 Cl. Ct. 714 (1991), aff’d, 988 F.2d 1135 (Fed. Cir. 1993)

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LIMITS ON TAXING JURISDICTION - (Offshore) Exploration and Exploitation


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• Source country may tax only if:

• Income is subject to tax;

• Sourced to that country; and

• A double tax treaty does not prevent or limit taxation.

• Detailed vs broad sourcing rules; For example, United States:

• rental income - sourced where property is used;

• services - sourced where performed;

• transportation income - sourced where transportation begins and ends,

• etc.

• Income must first be classified into appropriate categories;

• De Beers India Minerals Pvt. Ltd. v. ITO, (2008) 113 TTJ (BANG) 101

LIMITS ON TAXING JURISDICTION Sourcing of Income


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Head Co(NL)

Op Co(NL)

Netherlands

• Design Engineering Services

• Equipment Rental

United StatesGulf of Mexico

•Installation Services

LIMITS ON TAXING JURISDICTION Sourcing of Income Example


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• Within own territory includes offshore territory;

• States may voluntarily limit sovereign rights by concluding double tax treaties;

• Per Treaty (Art.3): covered areas outside of onshore boundaries;

• e.g. Art.3(1) Norway-UK Treaty:

• ‘the term United Kingdom means ‘Great Britain ... including any area outside the territorial sea of the United Kingdom which in accordance with international law has been or may hereafter be designated, under the laws of the United Kingdom concerning the Continental Shelf, as an area within which the rights of the United Kingdom with respect to the seabed and subsoil and their natural resources may be exercised.

• Heerema Marine Contractors SA v. Ministry of Finance and Customs, Case Number 122/1992.

LIMITS ON TAXING JURISDICTION Double Tax Treaties


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• Jurisdiction to tax (CLS);

• Offshore territories: connection to exploration and exploitation;

• Limited source taxation; Activity generates type of income that is taxable under domestic law;

• Activity rises to a trade or business under domestic legislation; or

• Double tax treaties: activity rises to level of PE under tax treaties.

LIMITS ON TAXING JURISDICTION Summary


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• PE main criterion for taxing rights of the Source country;

• OECD MC Article 7 - general rule: • only where business conducted through a PE under Article 5;• only the profits attributable to that PE;

• Gross or net basis taxation by the Source country;

• OECD MC Article 5(1) - General definition of PE; Series of tests:

1. Place of business• Any premises, facilities, or installations used for carrying on business;• Whether or not used exclusively;• Machinery and equipment;

DOUBLE TAX TREATIESImportance of the PE Concept


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• OECD MC Article 5(1) - General definition of PE; Series of tests (c’d):

2. Fixed place of business- link to a specific geographic point;• Equipment need not be fixed to the soil; enough if remains on particular site;• C(5)(20) - “The very nature of a construction or installation project may be

such that the contractor’s activity has to be relocated continuously or at least from time to time, as the project progresses. This would be the case for instance where roads or canals were being constructed, waterways dredged, or pipelines laid…”;

• Permanence test;

3. Carry on business ‘through’ a fixed place of business;• Broad meaning; e.g. company paving roads;• Factual use test.



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• Exploitation Activities

• Article 5(2) - ‘positive list’;• a mine, an oil or gas well, a quarry or ‘any other place of extraction’ of

natural resources;• includes all places of extraction whether on or offshore;

• Particular problems:

• pipelines

• exploration activities - OECD MC leaves determination up to individual states.




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Preparatory & Auxiliary Activities

• OECD MC Article 5(4)(e) - the term “permanent establishment”does not include:

• 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;

• ‘Preparatory or auxiliary’ activities include specifically:

• use of facilities for storage, display or delivery of goods;

• maintenance of stock of goods for such purpose; or for processing by another enterprise; or

• the maintenance of a fixed place of business for purchasing goods or for collecting information;

• Decisive criterion: activity forms ‘essential and significant’ part of the business;




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Preparatory or Auxiliary Activities

OECD Comm. guidance: overall activity is preparatory or auxiliary; activity is insignificant; supports own business; acts as many ‘tentacles’; services are remote from realization of profit; purpose is remote from general purpose; services do not constitute an essential part of the business.

Exploration Activities - PE or preparatory or auxiliary character?

• Distinction may be drawn on several factors:

• part of core activities;

• too significant to be preparatory;

• probably meets all tests of Article 5(1);

• substantial equipment is used;

• significant cost;

• the exploration is a fixed place of business.© 2015 Carrara Legal BV

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Substantial Equipment PE

• Use of substantial equipment sufficient to constitute PE;

• Under OECD MC - not directly relevant whether PE exists;

• Australian, Canadian treaties include concept; e.g. Australia - Singapore treaty 1969, Art.5(3)(b):

• ‘An enterprise of a Contracting State shall be deemed to have a permanent establishment and to carry on trade or business through that permanent establishment in the other Contracting State if ... substantial equipment is being used in that other State’..

• McDermott Industries (Aust) Pty Ltd v Commissioner of Taxation 2005 ATC 4398 - chartering of barges represented substantial equipment;


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Building, Construction & Installation

• OECD Model Art.5(3) - “A building site or construction or installation project constitutes a permanent establishment only if it lasts for more than twelve months”;

• UN Model reduces threshold to 6 months; International trend to reduce threshold for offshore activities;

• C 5(3)(16) - An office or workshop which does not meet definition, even if there is within it an installation, does not constitute a PE;

• C 5(3)(16) - If office or workshop used for a number of construction projects, and activities more than incidental, it will be a PE, even if none of the projects last for 12 months.



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Building, Construction & Installation - Definition

• OECD C(5)(3)(17) - Site or Project “includes not only the construction of buildings, but also the construction of roads, bridges, canals,..., the laying of pipelines, and excavating and dredging”;

• Not restricted to ‘construction’ project; may include installation of equipment;

• Includes on-site planning and supervision;

• US Model Art.5 (3) - “A building site or construction or installation project, or an installation or drilling rig or ship used for the exploration of natural resources, constitutes a permanent establishment only if it lasts, or the exploration activity continues for more than twelve months.”



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Building, Construction & Installation - Site or Project

• Distinction is significant when determining when a ‘site’ or ‘project’ actually begins; e.g. activities take place in country, but not at site;

• C 5(3)(19) - A “site” exists from the date on which the contractor begins his work, including any preparatory work, in the country where the construction is to be established, for example, if he installs a planning office for the construction”;

• Work not limited to the actual physical site when work performed by the general contractor!



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Building, Construction & Installation - Site or Project example:


Contractor Co(NL)

Country of Site

Offsite 1-1-2010

Installation beginning 1-6-2010

Netherlands


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Building, Construction & Installation - Site or Project

• C 5(3)(19) - “If an enterprise (general contractor) which has undertaken the performance of a comprehensive project subcontracts parts of such a project to other enterprises (subcontractors), the period spent by a subcontractor working on the building site must be considered as being time spent by the general contractor on the building project.”



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Building, Construction & Installation - Site or Project example:


Contractor Co(NL)

Country of Site

Offsite 1-1-2010

Installation beginning 1-6-2010

Netherlands

SubContractor Co

EngineeringDrawingsProcurement


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Geographic Unity

• Geographic Proximity of projects;

• Facts & circumstances.

Commercial Unity

• Identity of Contract;

• Separate bidding & negotiation;

• Identity of client;

• Connection between projects.



Building, Construction & Installation - Commercial & Geographic Unity

• C 5(3)(18) - A building site should be regarded as a “single unit”, even if it is based on several contracts, provided that it forms a coherent whole commercially and geographically.

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Building, Construction & Installation

• Preparatory Work;

• On-Site Planning & Supervision;

• Fabrication: C 5(3)(20) -‘where parts of a substantial structure such as an offshore platform are assembled at various locations within a country and moved to another location within the country for final assembly, this is part of a single project’.

• Mobilization days;

• Interruptions; C 5(3)(19) - ‘A site should not be regarded as ceasing to exist when work is temporarily discontinued. Seasonal or other temporary interruptions should be included in determining the life of a site’.

• Completion:

• Plant or equipment “finally taken over by the client” (Skaar);• After sales services, warranties;• Demobilization days;• Completion Certificates.



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Offshore Clauses

• Income from ‘offshore activities’ over a certain period threshold may be taxed by the Source country regardless of whether there is a PE under Article 5 of the Treaty;

• Norway - UK Treaty, Article 23(5) - all petroleum related business activities performed offshore are deemed to establish a PE after 30 days within 12 month period;

• US - NL Treaty, Article 27(3) - “An enterprise of one of the States which carries on offshore activities in the other State shall,..., be deemed to be carrying on, in respect of those activities, business in that other State through a permanent establishment situated therein, unless the offshore activities in question are carried on in the other State for a period or periods not exceeding in the aggregate 30 days in a calendar year”



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Offshore Clauses

• Definition of Offshore Activities - Article 27(2) - activities carried on offshore in connection with the exploration or exploitation of the seabed and its subsoil and their natural resources, situated in one of the States;

• Two main requirements:

• Physical presence;

• Offshore activities;

• Periods of physical presence are aggregated; includes all offshore activities that are part of the same project.



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Contractor Co(NL)

Project A

Project B

1/9 - 5 days1/12 -10 days

1/11 - 4 daysSub Co(NL)

1/10 - 10 days

Project C1/6 - 20 days

•Project A + B = 29 days, no Art. 27 PE;•Project C = 20 days, not counted

Example::

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Offshore Clauses - Exceptions:

• Activities mentioned in paragraph 4 of Article 5;

• Towing or anchor handling by ships primarily designed for that purpose and any other activities performed by such ships;

• Transport of supplies or personnel by ships or aircraft in international traffic.



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DOUBLE TAX TREATIESTreaty Characterization of Activities


Oil CoMainContractor

Co

• Activities of (Offshore) Contractors and subcontractors

VesselCo

EquipmentCo

TugCo

SubCon

1

2 3 45

1. Lump Sum contract fees2. Subcontractors for survey, diving, fabrication, design, etc3. Rental of equipment4. Charter fees for installation vessels, barges and tugs5. Payments for towing tugs, harbour assist, heli flights etc

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OECD MC

• (S1) ‘The 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’.

• (S2) ‘If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that permanent establishment’.

• C(7)(1)(10) - ‘In taxing the profits that a foreign enterprise derives from a particular country, the tax authorities of that country should look at the separate sources of profit that the enterprise derives from their country’.

UN Model

• (7)(1) ‘[the] profits of an enterprise of [Country R] shall be taxed only in [Country R] unless the enterprise carries on business in [Country S] through a PE situated in [Country S]. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in [Country S] but only so much of them as is attributable to:

• that PE;

• sales in [Country S] of goods or merchandise of the same or similar kind as those sold through the PE; or

• other business activities carried on in [Country S] of the same or similar kind as those effected through that PE’.



• Classification and source of income is left up to the states; Taxing rights are then allocated under Article 7 or under a separate article;

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Contract Fees• Business Profits: only part of the contract amount that is effectively carried out

by the PE;• Contractual allocation of fees:

• Design & Engineering • generally only activities in country of site;• Contract amount divided between Head office and the PE;

• Fabrication• Sourced to the country of site if performed there;• Part of, or preparatory to, building, construction or installation activity;

• Transportation • Ships in international commerce - taxable solely by residence state;• Not in international commerce - taxable by source state if PE;• Goods carried in own ships to a PE in another state, none of the profit can

properly be taxed by that state (OECD Comm. Art.8, Para. 20)



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Contract Fees• Mobilization

• First approach: distinctly separate activity• Second approach: integral part of installation activities• Third Approach: partly within and partly outside the country of site;

• Installation• Generally sourced to the country of site;• No PE - in general, not transportation income;

• Demobilization • treatment of income consistent with the analysis for mobilization

• Conclusion:• Gross income is assessed on the actual compensation/fees for the taxable

activity in the source country;• Contract amount used as the basis, minus payment for services that are not

liable to tax.



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Charter Fees• Payments for “the use or the right to use” a vessel in offshore activities:

• Leasing or rental income• Income from the performance of services • Royalties

• Bareboat Charters• “True lease” - Lessee is in complete possession, control, and command of

the vessel; • Risk of performance and economic risk on lessee.

• Time Charters• Services - Lessor remains in full control for the navigation and management

of the ship and its crew;• Operational and economic risk remains with the owner of the ship;• Gulf Offshore N.S. Limited vs. Her Majesty the Queen, 2007 CAF 302

(2007);



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Payments to Subcontractors• Royalties; • Technical Service Fees

• Design & Engineering services• previously developed designs

• Advisory and Consultancy Services• Other

• Industrial, commercial or scientific experience• Services



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Fees for the use of tugs (tow, harbour assist, anchor handling, supply etc)• Taxation under Article 7 or a separate article generally depends on

characterization as bare boat charter or time charter;• Exempt under Offshore Clauses.

Equipment Rentals• Royalty

• “use of, or the right to use” property• Business Profits• OECD Model removed ‘rental of equipment’ from definition of royalty,

taxable under Art.7.



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OIL & GAS CROSS BORDER ACTIVITIES


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Questions?

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oil & gas cross border activities - ibfd · 2015-06-30 · •within own territory includes...

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