On October 31, 2014, the OECD published the Discussion Draft on BEPS Action 7, Preventing the Artificial Avoidance of Permanent Establishment (‘PE’) Status. In this Discussion Draft, changes were proposed to the definition of PE to prevent the artificial avoidance of PE status in relation to BEPS, through i) commissionaire arrangements, ii) specific activity exemptions, iii) the splitting-up of contracts, and in relation to iv) insurance.

Public comments on this discussion draft were invited and a public consultation meeting took place on January 21, 2015. In March 2015 the Working Party on Tax Conventions and Related Questions moved from a series of alternative options to one preferred proposal, which is contained in the revised discussion draft released on May 15, 2015.

A selection of the relevant conclusions relating to the proposed amendment to the definition of PE in Article 5 of the OECD Model Tax Convention are discussed below.

Commissionaire arrangements

The OECD recognizes that in many cases it is clear that commissionaire arrangements and similar strategies are put in place to erode the taxable base of the State where the sales took place. The Discussion Draft defines commissionaire arrangements as ‘an arrangement through which a person sells products in a given State in its own name but on behalf of a foreign enterprise that is the owner of these products’. The revised Discussion Draft lowers the threshold for recognizing a PE subject to the following conditions being met:

  • a person acts in a Contracting State on behalf of an enterprise;
  • in doing so, that person habitually concludes contracts, or negotiates the material elements of contracts; and
  • these contracts are either in the name of the enterprise or for the transfer of the ownership of, or for the granting of the right to use, property owned by that enterprise or that the enterprise has the right to use, or for the provision of services by that enterprise.

An exception applies if the activities performed by the person on behalf of the enterprise are carried on as an independent agent (e.g. a broker, general commission agent or any other agent with an independent status). However, based on the proposed wording, the independent agent exception is more difficult to meet, i.e. based on this Discussion Draft if a person ‘acts exclusively or almost exclusively on behalf of one or more enterprises to which it is connected’ that person will no longer be considered an independent agent.

Specific activity exemptions

The specific activity exemptions refer to the list of exceptions included in Article 5, paragraph 4 of the OECD Model Tax Convention, according to which a permanent establishment is deemed not to exist where a place of business is used solely for activities that are listed in that paragraph (such as the use of a warehouse or maintenance of a stock of goods or merchandise for storage, display, delivery or processing). The revised Discussion Draft proposes making all exemptions subject to a ‘preparatory and auxiliary’ condition.

New anti-fragmentation rule

The revised Discussion Draft also contains a proposal that would require taking into account the activities carried on by the same enterprise at different places or where a connected enterprise carries on activities at the same place or at another place in the host country. If one of the activities carried on by a connected party constitutes a permanent establishment or the overall activity resulting from the combination of the two activities is not of a preparatory or auxiliary nature, the specific activity exemptions would no longer apply. For these purposes, a permanent establishment includes the activities of a connected enterprise incorporated in the host country.

The splitting-up of contracts

Article 5, paragraph 3 of the OECD Model Tax Convention includes a twelve-month period for construction or installation projects. This twelve-month period is also a concern for the Working Party in the case of treaties that contain a service PE provision. The BEPS Action 7 revised Discussion Draft includes a proposal to adopt the general Principal Purpose Test rule (‘PPT’, i.e. whether the splitting-up of contracts is tax-motivated) proposed in the Report on BEPS Action 6. If a country does not implement the PPT rule, it is recommended they exclude situations where there are legitimate business purposes for the involvement of connected enterprises in the same project.


In contrast to the first Discussion Draft, the revised Discussion Draft no longer proposes an alternative treatment of insurance activities in the PE definition.

Profit attribution

The original Discussion Draft included almost no comments on the attribution of profits and how such an attribution would be affected by the proposals for changing the PE standard. The revised Discussion Draft acknowledges that work on the attribution of profits can only be undertaken after the work on Action 7 and Actions 8–10, in particular Action 9 (Risks and Capital), has been completed. Follow-up work on profit attribution will therefore be carried on after September 2015.

Concluding remarks

The revised Discussion Draft provides for one option per type of avoidance strategy and, compared to the first Discussion Draft, the threshold for having a PE is generally narrower. However, the current wording still contains a large amount of subjective content, which creates uncertainty for taxpayers. In addition, especially in relation to the proposed adjustments for capturing commissionaire arrangements and the specific activity exemptions, it is expected that the number of PEs will increase significantly (also in situations that currently do not lead to a PE), whereas limited profits can often be attributed to such a PE. The proposals would also increase the compliance burden for taxpayers as well as increasing the likelihood that disputes about this compliance burden may arise.

At this point it is still unclear if and to what extent the OECD Member States will include these proposals in their treaties. Moreover, the proposals should also be read in conjunction with the outcome of BEPS proposals on the allocation of profits, which also still need to be finalized. We recommend that you review your existing and proposed business structures to determine whether this revised Discussion Draft will impact your company and, if so, how. Depending on this analysis, companies may consider potential changes to their business structure.

Public comments on the revised Discussion Draft should be submitted no later than June 12, 2015 and will be discussed at the Working Party meeting on June 22-26, 2015. The Working Party will then produce a final draft of the report on Action 7.

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