Controversy over OECD changes to permanent establishment rules

Multinational corporations are opposing new international proposals that would lower the threshold for finding that a company has a permanent establishment in a particular jurisdiction.

The proposals are part of the Organization for Economic Development and Cooperation’s Base Erosion and Profit Shifting (BEPS) project, aimed at preventing arbitrage-based tax-planning schemes used by multinational companies. Many such schemes attempt to avoid having a permanent establishment (PE) in countries where the company generates significant revenues, thus avoiding corporation taxes in those jurisdictions.

The proposed new PE rules comprise Action 7 of the OECD’s BEPS plan. This sets out 14 options for modifying the internationally accepted criteria to decide whether a permanent establishment exists. They would also eliminate some of the existing customary exemptions from PE status.

The level of disagreement on PE is probably greater than in any of the other BEPS actions, with the OECD having received more than 800 pages of comments on its PE proposals. These were discussed at a meeting last week, at which representatives of business expressed their concerns. They noted that the current PE rules have worked well for the past 50 years, providing certainty and stability for cross-border trade and investment.

Three main observations were made at the meeting. First, any rule which would make it easier for governments to establish the presence of a PE would almost certainly increase the substantive and administrative costs for cross-border transactions – for example creating PEs for marginal activities.

Second, some of the proposed changes use subjective language that could produce ambiguities, and would inevitably create disputes between countries and increase the risk of double taxation, particularly for so-called commissionaire arrangements.

Third, the proposed options affect the balance of taxing rights between the source and residence country. That balance is not part of the BEPS project and it should be discussed directly rather than by adjusting the PE rules.
Business commentators noted that changes to the PE threshold would impact on other articles in the OECD Model Tax Convention and would have implications beyond corporate income tax – for example on value-added tax. They also suggested that some of the perceived profit-shifting issues could be dealt with by proper application of transfer pricing principles, rather than the proposed changes to the PE standard.

The OECD working group will meet in March to further consider the proposals and the comments received. A revised draft will be issued in the spring.

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