Transfer Pricing Perspectives: The new normal: full TransParency

Implications of the new permanent establishment definition on retail and consumer multinationals

34 Perspectives: The new normal: full TransParency Implications of the new permanent establishment definition on retail and consumer multinationals

One of the most far-reaching outcomes of The key changes to the definition of a the Organisation of Economic Co-operation PE can be summarised as follows: and Development’s (OECD’s) base erosion The key changes to the definition of a PE and profit shifting (BEPS) project is the can be summarised as follows: modification of the definition of a PE. • Dependent agent PE. Currently a PE In Action 7 of the BEPS project, the OECD arises when an agent acting on behalf tries to tackle common avoidance of a foreign enterprise habitually strategies used to prevent the existence exercises authority to conclude of a PE, including through agency or contracts in the name of the enterprise, commissionaire arrangements instead of unless the agent is an independent establishing related distributors. Action 7 agent (legally and economically also aims to prevent the misuse of specific independent from its principal) acting exceptions to the PE definition, which in the ordinary course of its business. relate to activities of a preparatory and Since the current definition is limited auxiliary character. The changes in the PE to the formal conclusion of contracts, definition have significant consequences the OECD widened it to also include for international groups. Some sectors, situations in which an agent habitually especially the retail and consumer (R&C) plays the principal role leading to the industry, seem to be even more exposed conclusion of contracts that are then than others to the changes. routinely concluded without material In Action 7 of the BEPS project, the OECD tries to tackle modification by the enterprise. common strategies used to prevent Effecting the changes to the PE definition • Specific activity exemptions and anti- will require amendments to bilateral tax the existence of a PE, including through agency or fragmentation rules. Under the current treaties. To facilitate this process, the OECD regulations, a PE is deemed not to exist commissionaire arrangements instead of establishing is working on a multilateral instrument that when a place of business is engaged will implement the results of - related distributors. solely in certain activities (such as related BEPS measures in existing bilateral maintenance of stocks of goods for tax treaties. The instrument should be storage, display, delivery or processing, ready for signature by the end of 2016. It is purchasing of goods or merchandise, expected that the changes proposed by the collection of information). With the OECD may be effective from 2017. revised regulations, the exclusion will apply only when these activities are preparatory or auxiliary in relation to the business as a whole. Anti-fragmentation

35 Transfer Pricing Perspectives: The new normal: full TransParency Implications of the new permanent establishment definition on retail and consumer multinationals

rules have also been introduced to forms an essential and significant part of The other model used by multinationals prevent the breakup of an operating the overall activity of the enterprise. In involves a central purchasing department business into several small business units particular, the activity cannot be regarded that provides support services for the in order to benefit from the preparatory as of a preparatory or auxiliary nature operating companies that purchase or auxiliary exemption. As a result of the when the general purpose of the activity goods directly from suppliers. Such new provisions, the activities performed performed by the place of business is the support usually includes selecting and by different related parties are to be same as the general purpose of the whole recommending suppliers, negotiating combined (analysed on an aggregated enterprise. For companies operating in the global purchase agreements with suppliers, basis) when assessing whether they R&C industry, activities such as purchasing and supporting negotiations with local can be regarded as of a preparatory or or warehousing typically correspond to a suppliers. So far, such activity has not been auxiliary nature. company’s core business activities and thus sufficient to create a PE. these companies may no longer benefit • Splitting up of contracts. According from the existing activity exemptions. Under the new regulations, one may argue to the existing provisions, a PE arises Further considerations on the potential on the one hand that in this scenario the when work on a construction site lasts influence of the new PE regulations on dependency condition is not met, as the at least 12 months. In order to prevent purchasing and warehousing functions are central department does not follow the splitting up contracts artificially into presented below. instructions of the operating companies but shorter periods, the OECD advocates for rather instructs them on how to execute a principal purposes test,1 or a specific Purchasing the purchasing process. Thus, the central provision that allows for combining purchasing department should be perceived the activities of the related enterprises R&C multinationals often use central as an independent agent. However, because carried out at one construction site buying entities to streamline purchases. in principle such services are provided during different periods of time, each These entities are typically represented for the benefit of group entities only, tax exceeding 30 days, when determining in local markets by related party service authorities might claim that the central the duration of work. providers or purchasing offices. In principle, purchasing department does not in fact responsibilities of such local units include meet the independent agent condition, What are the main concerns of these searching, auditing, and selecting suppliers which would result in the creation of a changes for R&C multinationals? as well as negotiating with suppliers with PE (provided that all other conditions are The most significant impact on R&C regard to products and the commercial met). This example shows that the inherent multinationals will likely result from the terms of cooperation. Under the new PE subjectivity of the new provisions triggers changes to the specific activity exemptions. definition, such local places of business will a risk of creating a PE even when tax is not constitute a PE, as the purchasing function the key driver behind the arrangement. According to the OECD, the decisive factor is an essential and significant part of the used to assess whether a given activity can enterprise’s overall activity (consisting of be regarded as preparatory or auxiliary 1 This rule is one of the outcomes of Action 6 of the BEPS project on the prevention of treaty abuse. According selling these goods). to this rule, if one of the principal purposes of a transaction or arrangements is to obtain treaty benefits, these involves determining whether the activity benefits will be denied unless granting them would be in line with the object and purpose of the provisions of carried out by the place of business in itself the treaty.

36 Transfer Pricing Perspectives: The new normal: full TransParency Implications of the new permanent establishment definition on retail and consumer multinationals

of an enterprise’s distribution business In order to prepare for the new regulations, and therefore do not have a preparatory multinationals should review their existing or auxiliary character. As a result, under structures or planned arrangements. the new PE definition, these local places In particular, they should analyse the of business are likely to constitute a PE of activities performed by their entities/ the enterprise. places of business from the perspective of the value chain of the whole enterprise in Overall impact of the changes order to identify activities that could give The existence of a PE does not rise to a PE, and measure the impact of any automatically mean a material increase potential PE on the business. Depending in tax exposure (although it is likely to on the outcomes of this analysis, taxpayers trigger additional compliance costs and might need to revise their business models administrative burden for businesses), or gather and document arguments especially where the local place of business supporting their position. already receives arm’s length remuneration. In most cases, remuneration based on costs incurred by the PE should be appropriate, though there may be situations in which remuneration based on commission would be more suitable. This might apply Authors in particular when a local unit either Warehousing concludes contracts with suppliers or plays Susann van der Ham Currently, most R&C the principal role leading to the conclusion Currently, most R&C multinationals PwC Germany of contracts that are then routinely multinationals are are involved in online sales, with some concluded without material modification by +49 211 981 7451 international sellers engaged solely in involved in online sales, the enterprise. Selection of the appropriate digital sales. Online sales usually require [email protected] method of profit attribution to the PE, with some international that an enterprise maintain a warehouse as well as determining whether or not a abroad (with an adequate number of Robert Halat sellers engaged solely in given place of business constitutes a PE, employees) where goods owned by the are the areas where there is heightened PwC Germany digital sales. enterprise are stored and delivered risk of a dispute with tax authorities. This +49 211 981 4376 to local customers (once sold by the translates into uncertainty and increased enterprise). It seems indisputable that [email protected] compliance costs, and may also result in storage and delivery activities to fulfil . online sales constitute an essential part

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