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Permanent establishments risk in Africa
EY Africa Tax Conference
September 2014
Page 2
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
Permanent establishments risk in Africa
Page 3
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
Permanent establishments risk in Africa
Page 4
Tax risk and controversy survey
EY 2014 Tax risk and controversy survey
► Reputation risk
► BEPS and legislative risk
► Enforcement risk
► Operational risk
Permanent establishments risk in Africa
Page 5
EY presence in Africa
EY office
No EY office, but support available
Permanent establishments risk in Africa
EY office
No EY office, but support available
Page 6
General PE and global perspective
Permanent establishments risk in Africa
Page 7
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
Permanent establishments risk in Africa
Page 8
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
Permanent establishments risk in Africa
Page 9
The PE concept
Permanent establishments risk in Africa
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
Page 10
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
Permanent establishments risk in Africa
Page 11
What is the relevance of changes to the OECD or UN Commentary?
Permanent establishments risk in Africa
Page 12
How to read PE survey results
Beware!
Looks “okay”, but the light may change
The “in-betweens”
Permanent establishments risk in Africa
EY PE Survey conducted by EY South Africa Office, 2013
Page 13
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
Permanent establishments risk in Africa
EY PE Survey conducted by EY South Africa Office, 2012
Page 14
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%
Permanent establishments risk in Africa
Page 15
Services PEs Which situations?
Country A Country B
“Fly-in”
consultant
Permanent establishments risk in Africa
Page 16
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.
Permanent establishments risk in Africa
Page 17
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
Permanent establishments risk in Africa
Page 18
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
Permanent establishments risk in Africa
Page 19
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%
Permanent establishments risk in Africa
Page 20
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
Permanent establishments risk in Africa
Page 21
Example Contract manufacturers and dependent agent PEs (DSM, Spain, 2008)
Permanent establishments risk in Africa
► 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.
Page 22 Permanent establishments risk in Africa
What is the risk of PE creation under a commissionaire arrangement (fact pattern similar to Zimmer)?
Page 23
PE survey results Commissionaire
Botswana
Ghana
Kenya
Mauritius
Mozambique
Namibia
Nigeria
South Africa
Tanzania
Austria
Belgium
Denmark
Finland
Germany
Greece
Norway
Turkey
Spain
Africa Rest of the world
High
Low
Medium
Permanent establishments risk in Africa
EY PE Survey conducted by EY South Africa Office, 2012
Page 24
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
Permanent establishments risk in Africa
Principal Agent
Goods or
services Customer
Commission payment
Invoice for commission
Supply
Page 25
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
Permanent establishments risk in Africa
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
Page 26
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%
Permanent establishments risk in Africa
Page 27
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
Permanent establishments risk in Africa
Page 28
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
Permanent establishments risk in Africa
Page 29
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).
Permanent establishments risk in Africa
Page 30
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%
Permanent establishments risk in Africa
Page 31
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
Permanent establishments risk in Africa
Page 32
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
Permanent establishments risk in Africa
Page 33
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
Permanent establishments risk in Africa
Page 34
Where a foreign enterprise operates in your jurisdiction exclusively through subcontractors, would it be considered to be carrying on business in your jurisdiction?
Permanent establishments risk in Africa
Page 35
PE survey results Sub-contracting
Botswana
Ghana
Kenya
Mauritius
Mozambique
Namibia
Nigeria
South Africa
Tanzania
Australia
Belgium
Canada
Finland
Germany
Greece
Norway
Turkey
UK
Africa Rest of the world
Yes
No
Unclear
Permanent establishments risk in Africa
EY PE Survey conducted by EY South Africa Office, 2012
Page 36
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%
Permanent establishments risk in Africa
Page 37
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?
Permanent establishments risk in Africa
Page 38
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
Africa Rest of the world
Yes
No
Unclear
Permanent establishments risk in Africa
EY PE Survey conducted by EY South Africa Office, 2012
Page 39
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%
Permanent establishments risk in Africa
Page 40
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
Permanent establishments risk in Africa
Operating sub-
manufacturing
distributor
Swiss parent
Customers
Supply of goods Manufacturing
Payment for goods
ROI 100%
Page 41
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
Permanent establishments risk in Africa
Operating sub-
manufacturing
distributor
Swiss parent
Customers
Sale of goods and
invoicing
Manufacturing
Payment for goods Manufacturing
and sales
agreement
Delivery of goods
Page 42
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?
Permanent establishments risk in Africa
Page 43
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.
Permanent establishments risk in Africa
Page 44
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)
Permanent establishments risk in Africa
Page 45
Concept of “delivery” (X Ltd vs APEH, Hungary, 2008)
Permanent establishments risk in Africa
► 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
Page 46
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%
Permanent establishments risk in Africa
Page 47
Other Time limits
Permanent establishments risk in Africa
Page 48
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?
Permanent establishments risk in Africa
Page 49
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?
Permanent establishments risk in Africa
Page 50
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
Africa Rest of the world
Yes
No
Unclear
Permanent establishments risk in Africa
EY PE Survey conducted by EY South Africa Office, 2012
Page 51
Way forward
Permanent establishments risk in Africa
Page 52
Where should taxpayers head from here?
► Planning
► Implementation
► Dispute resolution
Permanent establishments risk in Africa
Page 53
Where should taxpayers head from here?
Permanent establishments risk in Africa
► 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.
Page 54
Questions
Permanent establishments risk in Africa
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