The purpose of Action 7 of the BEPS action plan is to prevent the use of artificial agreements and tax avoidance structures that have been used by tax payers to avoid the creation of PE and thus tax liability in the given country. Action 7 recommended changes to the PE definition in Article 5 of the OECD Model Tax Convention on Income and Capital („MTC”).
Preparatory or auxiliary activities
Based on Section 4 of Article 5 of the MTC, activities considered to be merely preparatory or auxiliary do not generate permanent establishment for the company in the country where the preparatory or auxiliary activities are performed.
In line with Action 7, the list of activities considered to be auxiliary and preparatory has been limited by implementing Section 4.1. to Article 5. It prevents the avoidance of PE in case of activities, which might be viewed in isolation as preparatory or auxiliary in nature, but that constitute part of a larger set of business activities performed by the enterprise or its related enterprise (“anti-fragmentation rule”).
The reason for the modifications recommended by Action 7 is that certain activities previously considered to be merely preparatory or auxiliary in nature are nowadays correspond to core business activities. Furthermore, certain enterprises in order to avoid PE status and taxation in the given country, artificially fragmented their business activity into several small operations in order to support that each part is merely engaged in preparatory and auxiliary in nature.
The other significant modification recommended by Action 7 is the modification of the provisions applicable for intermediaries / agents under Section 5 and 6 of Article 5 of the MTC. The activities performed by an intermediary in the course of an independent business does not result in a PE for the foreign enterprise in the country where the intermediary performs these activities on behalf of the enterprise. In order to prevent the abuses deriving from the intermediaries’ activities the respective provisions of the MTC have been modified.
Based on Section 5 of Article 5 of the MTC, the enterprise should be considered to have a permanent establishment in the country where a person (intermediary / agent) acts on behalf of the enterprise and in doing so, habitually concludes contracts or habitually plays principal role leading to the conclusion of contracts that are routinely concluded without material modification of the enterprise. This provision applies to contracts which are concluded either in the name of the enterprise, or for the transfer of goods or services by the enterprise. Based on Section 6 of Article 5, an agent cannot be independent, if acts exclusively or almost exclusively on behalf of one or more enterprises to which it is closely related.
If the business activities performed by the foreign enterprise are not considered to be complementary functions and constitute part of the cohesive business operation or if the foreign enterprise engages an intermediary who is cannot be considered as independent from the enterprise, the foreign enterprise deemed to have a permanent establishment in the given country. It means that, the profit attributable to the permanent establishment is subject to income tax in the country where this PE deemed to exist.
It is advisable for multinational enterprises to revise whether their business structures in respect of cross-border sales (including the activities of an intermediary) result in a deemed permanent establishment of the enterprise in the foreign country, considering the implemented amendments proposed by BEPS 7.