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Rich Source Countries CCSI Briefing Note Luis M. Almeida and Perrine Toledano1,2 March 2018 UnderstandingCCSI Briefing Note how the various definitionsLuis of Permanent Almeida and Perrine Establishment Toledano1,2 March 2018 can limit the taxation ability of resource- rich source countries Key CCSI Points Briefing Note Luis Almeida and Perrine Toledano1,2 March 2018 Double Taxation Agreements (DTAs) are bilateral tax treaties that are designed to reduce the negative impact of double taxation through the Understanding 1 allocation of taxing rights to how the State the of residence various (i.e. where thedefinitions company has its base) of and Permanent to the State of source (i.e.Establishment where the taxable operations takes place); canCCSI limit Briefing the Note taxation ability of resource- richLuis so Almeidaurce countries and Perrine Toledano1,2 The allocation of the rights to tax business profits of non-resident entities’ operations depends on whether these operations can constitute a Key1 Points March 2018 2 “Permanent Establishment” (PE) according to the definition included in each DTA. If non-resident entities fulfill the criteria established in this PE definition, taxation is due at the source State. On the contrary, if non-resident entities fall outside of the scope of this definition, the residence State obtains these rights. DTAs can therefore result in source States losing significant tax revenue from operations of non-residents (unless such Ke2 Luis Almeida and Perrine Toledano1,2 UnderstandingCCSIoperations Briefing are conducted Note under how a PE); the various definitions of Permanent Establishment March 2018 cany Loosely limit defining the the PEtaxation without due regard ability for the risk of of resourceloopholes might encourage- rich companies source to structure countries their investments in order to avoid 3 PoKey2 fulfilling Points the criteria of the PE definition and thus avoid taxation at source; int CCSIFor theBriefing purpose of Noteextractive industries, these tax avoidance structures normally involveLuis bypassing Almeida the time and threshold Perrine that trigger Toledanos a PE (by splitting1,2 4 long term contracts into short term contracts), and/or structuring and dividing contracts to enable them to be considered of preparatory or auxiliary 3 s21 March 2018 nature, thus fitting into then general exclusions of PE that exist in most DTAs (fragmentation of activities and/or misuse/abuse of specific activity Understanding how the various definitions of Permanent Establishment exemptions); 4 Keycan3 Under Pointslimit the Base the Erosion taxation and Profit Shifting ability (BEPS) project, of resource the OECD has proposed- rich a Multilateral source Convention countries aimed at tackling tax evasion 1,2and CCSI21 Briefing Note Luis Almeida and Perrine Toledano 5 avoidance schemes. This convention includes measures to prevent the artificial avoidance of a PE through contract splitting and through the March 2018 4 fragmentation of business operations. Unfortunately, as States are given much flexibility to renegotiate their DTAs and adopt these measures, it is 3 unlikely that resident States will have an incentive to change the status quo. In other words, many of the problems that DTAs create for source Ke 2 5 countries will likely remain unchanged; Understanding how the various definitions of Permanent Establishment1,2 CCSI Briefing Note Luis Almeida and Perrine Toledano 4 In addition, the UN and OECD Model DTAs – normally used as basis for DTAs - are not aimed at covering the specific characteristics of extractive Key3 Points can26 limit the taxation ability of resource- rich source countriesMarch 2018 y 5 industries. Resource rich States should thus aim to include specific clauses that cover these issues; after explaining the various options to optimize taxing rights related to PE in the context of extractives, this brief presents a sample PE clause to that effect as well an offshore and withholding 4 3 tax clause both aimed at protecting source State’s position in DTAs (Annexes III-V). 26 Po 5 KeyUnderstanding4 Points how the various definitions of Permanent Establishment 3 to enable them to be considered of preparatory or auxiliary nature, thus fitting into then general exclusions of PE that exist in most DTAs int 6 5 (fragmentation of activities and/or misuse/abuse of specific activity exemptions); can limit the taxation ability of resource- rich source countries 4 Under1 the Base Erosion and Profit Shifting (BEPS) project, the OECD has proposed a2 Multilateral Convention aimed at tackling tax evasion and 3 Luis M. Almeida is a private practitioner specialized Acknowledgments: The authors are particularly grateful to John avoidance schemes. This convention includes measures to prevent the artificial avoidanceBush, James of a PE Reynolds through and contract Joe Guttentag splitting ofand the through International the s 6 in tax policy in developing countries and 5 collaborates with CCSI and Perrine Toledano is Senior Lawyers Project and to Nicolas Maennling and Tehtena fragmentation of business operations. Unfortunately, as States are given1 much flexibility to renegotiate their DTAs to adopt these measures, it is Head of Extractive Industries at CCSI. Mebratu-Tsegaye of CCSI for their extensive inputs and support. Key4 unlikely Points that resident States will have an incentive to change the status quo. In other words, many of the problems that DTAs create for source Understanding how the various definitions of Permanent Establishment 6 5 countries will likely remain unchanged; canIn addition,limit the the UN and taxation OECD Model DTAs ability – normally of used resource as basis for DTAs- -rich are not aimedsource at covering countries the specific characteristics of extractive 1 Luis Almeida is a private practitioner specialized in Table of content Key Points..................................................................................................................................................................... 1 I. Introduction ......................................................................................................................................................... 3 II. What is a Permanent Establishment? .......................................................................................................... 7 III. Effect on extractive industries ..................................................................................................................... 13 IV. Base Erosion Profit Shifting ......................................................................................................................... 25 V. A way forward ................................................................................................................................................... 32 Annex I – Multilateral Convention article 13 – Artificial Avoidance of Permanent Establishment Status through the Specific Activity Exemptions ......................................................................................... 36 Annex II – Multilateral Convention article 14 – Splitting-up of Contracts ............................................. 39 Annex III – Proposed PE clause from an extractive industries’ perspective ........................................ 41 Annex IV– Proposed offshore clause .............................................................................................................. 45 Annex V – Withholding tax on technical services ....................................................................................... 47 2 I. Introduction In recent years, the increase in the globalization of trade and investment has had important implications in policy discussions on international taxation and the harmful effects of aggressive tax planning. These discussions have paved the way for a greater debate on double taxation agreements (DTAs); in order to prevent the double taxation of income, DTAs specify which State has the right to tax in a scenario where a company resident in State A (“Residence State”) receives profits from operations in State B (“Source State). However, by establishing these provisions, DTAs have also encouraged companies to create complex tax avoidance schemes. The Organisation for Economic Co-operation and Development (OECD) recently released several recommendations to tackle these practices under the Base Erosion and Profit Shifting (BEPS) project, which allowed for several international public consultations and discussions on tax evasion and avoidance. As an outcome of these discussions, the OECD ultimately released the “Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion Profit Shifting”1 (Multilateral Convention), a Convention that allowed for States to amend their existing DTAs in order to reduce the possibility of tax evasion/avoidance (due to its relevance, this subject is covered in more detail below). In addition, the OECD reviewed its own model DTA to also align it with the conclusions of the BEPS project. According to the International Monetary Fund (IMF)2, between 1975 and 2013 the number of existing DTAs rose from approximately 250 to nearly 3,000, despite a lack of evidence-based analysis on their economic and revenue impact. In the same study, the IMF warned that DTAs between the Netherlands and developing countries had led to a loss of revenue for the latter of at least €770 million in 2011. Non-OECD States that concluded DTAs with the United States may have lost approximately $1.6 billion
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