Oleg Konnov, Partner, Herbert Smith Freehills , Moscow Dr . Clemens Nowotny , Partner , LeitnerLeitner , Linz/Vienna

Oleg Konnov, Partner, Herbert Smith Freehills, MoscowDr. Clemens Nowotny, Partner, LeitnerLeitner, Linz/Vienna

Revised proposals concerning the interpretation and application of Article 5 of the OECD Model Tax Convention

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Agenda• Introduction: Overview on previous developments relating to

Art 5 OECD-MC• Revised proposals concerning the interpretation and

application of Article 5 OECD-MC – Overview• Selected examples of the revised OECD-proposals• Excursus: Relevance of later versions of OECD-Commentary for

the interpretation of tax treaties concluded prior to amendment

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Introduction: Overview on previous developments relating to Art 5 OECD-MC

• Definition of permanent establishment (PE) in Art 5 OECD-MC unchanged since 1977

• But: Commentary on Art 5 OECD-MC updated on a regular basis– Update 2003, 2008, 2010– Planned update 2014

• Updates of Commentary led to considerable lowering of PE-threshold– 2014 update will continue this trend

• Result: broadening of PE-concept giving more taxing rights to source states– Note: broadening is accompanied by Authorized OECD Approach (AOA) on how to

attribute profits to PEs– AOA follows “functionally separate entity approach”

• Notion of PE as distinct and separate enterprise• Almost unrestricted application of arm‘s length principle of Art 9 OECD-MC and guidance

given in OECD-Transfer Pricing Guidelines by analogy

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• Update 2003 of Commentary on Art 5 OECD-MC – Issue: Under which conditions is a place of business considered to be

“at the disposal of” an enterprise?• Inclusion of several examples in OECD-Commentary• “Painter-example” (para 4.5 OECD-Comm)

– A painter spends, for two years, three days a week in the large office building of its main client

– Presence of the painter in that office building where he is performing the most important functions of his business constitutes a PE

• Wide meaning of wording “through which” in Art 5(1) OECD-MC(para 4.6 OECD-Comm)– Should also apply to any situation where business activities carried on at a particular

location that is at the disposal of the enterprise for that purpose– E.g. an enterprise engaged in paving a road is considered to carry on its business

“through” the location where this activity takes place• Result: “loosening” of the criterion

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• Update 2003 of Commentary on Art 5 OECD-MC (cont)– Reduction of required degree of permanency (para 6 OECD-Comm)

• If nature of business is such that it will only be carried on for short period of time also very short period of time may suffice

• Activities of recurrent nature (which may extend over number of years): each period of time during which the place is used needs to be considered in combination

• Businesses carried on exclusively in source state also if of short duration– Extension of the geographical point – coherent whole commercially and

geographically (para 5 OECD-Comm)• An “office hotel” in which a consulting firm regularly rents different offices: single

place of business as building constitutes whole geographically place of business (para 5.2 OECD-Comm)

• A pedestrian street, outdoor market or fair in different parts of which a trader regularly sets up his stand: single place of business (para 5.2 OECD-Comm)

• A consultant who works at different branches in separate locations pursuant to single project for training employees : each branch considered separately (para 5.4 OECD-Comm)

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• Update 2003 of Commentary on Art 5 OECD-MC (cont)– Conclusion: PE-concept substantially broadened

• “through which” obtained the meaning of “at which”• Object of the activity = place of business being at the disposal of the enterprise• Mere location where service is rendered may constitute PE• Concept of commercially and geographically whole “introduced” in interpretation of

Art 5(1) OECD-MC• Reduction of timing requirements (e.g. recurring activities)

– German and Austrian tax authorities generally do not agree with OECD interpretation of “painter-example”• Germany: Observation in para 45.7 OECD Commentary• Austria: disapproving public letter rulings (e.g. EAS 2754)

– German tax authority does not agree with reduction of timing requirements• Observation in para 45.8 OECD Commentary

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• Update 2008 of Commentary on Art 5 OECD-MC– Principle: no source taxation of profits from services performed in a

Contracting State in the absence of a PE– Therefore, extension of PE-concept in Art 5(3)b UN-MC 1980 (“service PE”)

• “Deemed” PE without requirement of fixed place of business• Furnishing of services for a period or periods aggregating more than six

months (2011 version: more than 183 days) within any 12-months period constitutes PE

– Alternative provision on “service-PE” included in 2008 OECD-Commentary (para 42.23 OECD-Comm)• “More sophisticated” version of Art 5(3)b UN-MC• Physical presence required• Preparatory or auxiliary activities excluded• Taxation of net profits only

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• Update 2010 of Commentary on Art 5 OECD-MC– Further guidance on the meaning of “at the disposal of”– Satellites in geostationary orbit (para 5.5 OECD-Comm)

• Location of satellites not part of territory of a Contracting State• Satellite’s “footprint” not at disposal of the operator of the satellite no PE

– Roaming agreements (para 9.1 OECD-Comm)• Telecom operator enters into roaming agreement with foreign operator in order to

allow its users to connect to foreign operator’s telecom network• Foreign operator’s telecom network not at disposal of home operator no PE

– Use of cables or pipelines (para 26.1 OECD-Comm)• Cable or pipeline no PE for the customer of the operator of the cable or pipeline• Customer merely obtains transmission or transportation services and does not have

cable or pipeline at its disposal• Observation of Germany in para 43 OECD-Commentary (cf. BFH 30.10.1996, II R

12/92 “Pipeline-case”)

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Revised proposals concerning the interpretation and application of Article 5 OECD-MC – Overview

• Focus– Clarification of certain aspects of current definition– No revision of definition itself in Art 5 OECD-MC

• Content– 25 different issues brought to the attention of the OECD by business community

and tax administrations– Consolidated version of paragraphs 1 to 42.10 of the Commentary on Article 5

of OECD-MC attached to revised proposals– Revisions limited to specific issues and do not question the continued use of the

notion of PE– Attribution of income to PE (Article 7 OECD-MC) not addressed in proposals

• Role of OECD and Joint Working Group composed of delegates from Working Party 1 on Tax conventions and related questions and Working Party 6

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Revised proposals concerning the interpretation and application of Article 5 OECD-MC – Overview

• Timeline– 12 October 2011: public discussion draft on interpretation and application of Art 5 OECD-

MC released as of– until 10 February 2012: 43 public comments received – 7 September 2012: public consultation meeting– 12-13 September 2012: discussion with tax officials during OECD Annual Tax Treaty

Meeting– 19 October 2012: revised discussion draft released – until 31 January 2013: 29 public comments received– February 2013: comments examined at meeting of Working Party 1– Revised proposals available free of charge:

http://www.oecd.org/ctp/treaties/PermanentEstablishment.pdf• Final version to be included in 2014 update of Commentary to Art 5 OECD-MC• General critical remark

– Proposals are providing guidance by giving examples instead of principle-driven guidance– Examples sometimes look artificial and practical relevance is not always obvious

http://www.oecd.org/ctp/treaties/PermanentEstablishment.pdf

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Revised proposals concerning the interpretation and application of Article 5 OECD-MC – Overview (III)

• Relevant readings include:– Materials of 2009 Congress of International Fiscal Association (IFA) “Is

there are a Permanent Establishment?” (Cahiers de droit fiscal international, vol 94a)

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Selected examples of the revised OECD-proposals

• Meaning of “at the disposal of” (para 4.2 of the Commentary)

Whether a location may be considered to be at the disposal of an enterprise in such a way that it may constitute a “place of business through which the business of [that] enterprise is wholly or partly carried on” will depend on that enterprise having the effective power to use that location as well as the extent of the presence of the enterprise at that location and the activities that it performs there.

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• Meaning of “at the disposal of” (para 4.2 of the Commentary)– Inclusion of positive and negative criteria (non-exclusive) to clarify meaning – No abstract definition, since “at the disposal of” not included in wording of Art 5(1)

OECD-MC – Relevant criteria according to revised OECD-proposals:

• Effective power to use location– Exclusive legal right to use particular location (e.g. legal possession, lease) clearly sufficient– Also sufficient if enterprise is allowed to use specific location belonging to another enterprise or used

by a number of enterprises • extent of presence of the enterprise at that location and

– performs its business activities at that location on a continuous basis during an extended period of time

– Intermittent or incidental presence not sufficient (e.g. employees of an enterprise having access to the premises of associated enterprises which they often visit but without working in these premises for an extended period of time)

• the activities it performs there (with regard to Art 5(4) OECD-MC)– No disposal if enterprise has no right to be present and, in fact, does not use location

(e.g. plant of supplier or contract manufacturer no PE of client)

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Selected examples of the revised OECD-proposals• Meaning of “at the disposal of” (para 4.2 of the Commentary)

– Critical remarks:• Simple use of a specific location belonging to another enterprise or used by a

number of enterprises to perform services on a continuous basis for an extended period of time is also sufficient => continuance of “painter-example”– Is the mere performance of services (mere physical presence) sufficient? Stealth

introduction of the service PE alternative to Art 5(1) OECD-MC?– Or: Is it decisive that enterprise has effective power to determine time and manner of use in

the conduct of its business (see example on consultant working at client’s premises in revised OECD-proposals)? In line with German case law (BFH 4.6.2008, I R 30/07, on Dutch company performing cleaning services at German NATO-airbase)?

• To what does “extent of presence” refer?– Length of time required? Particular number of employees?

• What means “continuous” and an “extended period of time”? – No reference to six-months period (para 6 of the Commentary)– What is “intermittent” and “incidental”?

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• Meaning of “at the disposal of” (para 4.2 of the Commentary)– Critical remarks:

• BFH 4.6.2008, I R 30/07– Facts: Dutch company performing cleaning services at German NATO-airbase

» Employees of Dutch company have security passes for entrance; however, no premises are rented at the airport by Dutch company

» Only explicit authorization to use kitchen and break room as well as to perform their services in predefined security zones

» NATO provides equipment for cleaning of aircrafts in hangar– Findings:

» Mere performance of activities in the premises of the client does not give rise to required power to dispose over location

» Even if activity is performed throughout several years» Apart from timing issue: power of disposal requires autonomous claim of

taxpayer relating to access to room which serves the performance of the main activity (access shall not only be contingent upon provision of respective services in the room)

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• Home office as a PE (new para 4.8 and 4.9 of the Commentary)

Even though part of the business of an enterprise may be carried on at a location such as an individual’s home office, that should not lead to the automatic conclusion that that location is at the disposal of that enterprise simply because that location is used by an individual (e.g. an employee) who works for the enterprise. Whether or not a home office constitutes a location at the disposal of the enterprise will depend on the facts and circumstances of each case.

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• Time requirements for the existence of PE (para 6 of the Commentary)

The time requirement could similarly be met in the case of shorter recurring periods of time that would be dictated by the specific nature of the relevant business.

• Time requirements for the existence of PE (para 6 of the Commentary)– Rule of thumb: “experience has shown that permanent establishments …

have not been considered … where as business had been carried on … for less than six months” (para 6 OECD-Comm)

– Exception 1: activities of a recurrent nature• Example in OECD-proposals 2011: stand at commercial fair rented for 15

consecutive years where individual sells sculptures during a period of five weeks each year => existence of PE due to recurring nature – Conflict with case law of German Federal Fiscal Court (BFH 17.9.2003, I R 12/02):

stand at annual Christmas market for a period of four weeks each year no PE– Observation of Germany in para 45.8 OECD-Comm to para 6 OECD-Comm

• Modified example in revised OECD-proposals 2012: drilling operations at a remote arctic location; seasonal conditions prevent such operations from going on for more than 3 months each year but operations are expected to last for 5 years existence of PE due to recurring nature – But: Time requirement could similarly be met in case of shorter period of time

due to specific nature of relevant business


• Time requirements for the existence of PE (para 6 of the Commentary) – Exception 2: business with short duration because of its nature but

exclusively carried on in source State (“one-shot projects”) • Example 1: sole proprietor uses parents’ house in source State as cafeteria

to provide catering services to actors and technicians during a 4 months shooting of a TV documentary; enterprise terminated after 4 months period– existence of PE since cafeteria is only location where business is carried on; cafeteria

operated during whole existence of particular business

• Example 2: company (resident in State R) operating various catering facilities in State R operates a cafeteria in source State during a 4 week international sports event– no PE since company’s business, which is permanently carried on in State R, is only

temporarily carried on in source State


• Time requirements for the existence of PE (para 6 of the Commentary)– Critical remarks on recurrent activities (exception 1):

• Unfortunately still no clear-cut minimum time threshold – For establishment of a PE in general (e.g. 6 months)– For recurrent activities (e.g. minimum period of 3 months in each year?)

• Is nature of the location or specific nature of the relevant business decisive?• Is intended or expected multi-year duration of activity at time of

commencement of activity an obligatory requirement?• At which point in time will the recurrent activity constitute a PE?

– Existence of PE on a retrospective basis?– Intended or expected multi-year duration from the outset decisive?

– Critical remarks on one-shot projects (exception 2):• Is any short-term business (e.g. also for 1 week) exclusively carried on in

source State at risk to trigger a PE?


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• Presence of a foreign enterprise´s personnel in host country (para 10 of the Commentary)

As explained in paragraph 8.11 of the Commentary on Article 15, however, there may be cases where individuals who are formally employed by an enterprise will actually be carrying on the business of another enterprise and where, therefore, the first enterprise should not be considered to be carrying on its own business at the location where these individuals will perform that work. Within a multinational group, it is relatively common for employees of one company to be temporarily seconded to another company of the group and to perform business activities that clearly belong to the business of that other company. In such cases, administrative reasons (e.g. the need to preserve seniority or pension rights) often prevent a change in the employment contract. The analysis described in paragraphs 8.13 to 8.15 of the Commentary on Article 15 will be relevant for the purposes of distinguishing these cases from other cases where employees of a foreign enterprise perform that enterprise’s own business activities.

• Presence of a foreign enterprise´s personnel in host country (para 10 of the Commentary)– Issue: creation of PE via leasing personnel or personnel seconded

within MNE– In general: business is carried on by entrepreneur/employees/other

persons receiving instructions– Individuals formally employed by an enterprise but actually carrying

on business of another enterprise• first enterprise not considered to carry on its own business at the location where

these individuals perform that work no PE

– Temporary secondments within MNE• employees performing business activities that clearly belong to the business of the

receiving company reference to paras 8.13 to 8.15 of the Commentary on Art 15 (employer concept) to distinguish such cases from other cases where employees of the sending enterprise perform that enterprise’s own business


• Presence of a foreign enterprise´s personnel in host country (para 10 of the Commentary)– Example: Manager employed by manpower company

• Facts: SCO (resident in State S) operates hotel; SCO contracts with manpower company RCO (resident in State R) to obtain services of hotel managers; RCO is legal employer of hotel managers sent to SCO; RCO is paid “service fee” equal to total remuneration of hotel managers plus 25%

• Result:– According to Working Party 1, “it would be difficult to consider that RCO did not have a PE

in the situation where the managers were formally employed by RCO unless it was found that the managers were in fact ‘economically’ employed by SCO”

– However, if State S considers hotel managers to be “economically” employed by SCO, RCO does not have a PE in State S (cf para 8.11 of Commentary on Art 15)


• Presence of a foreign enterprise´s personnel in host country (para 10 of the Commentary)– Critical remarks:

• Important clarification that mere presence of employees who are seconded by foreign enterprise to another state do not in and of themselves constitute a PE of that foreign enterprise

• Are manpower companies at risk to trigger PEs in every State leasing personnel is sent unless source State applies economic employer approach?


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• Subcontracting all works to another person (paras 10 and 19 of the Commentary)

In that case, the site should be considered to be at the disposal of the general contractor during the time spent on that site by any subcontractor where circumstances indicate that, during that time, the general contractor clearly has the construction site at its disposal by reason of factors such as the fact that he has legal possession of the site, controls access to and use of the site and has overall responsibility for what happens at that location during that period.

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• Subcontracting all works to another person (para 10 of the Commentary)– Issue: Does an enterprise (contractor) have a PE if it subcontracts all parts of the

contract to other enterprises (subcontractors)?– Issue goes beyond Art 5(3) OECD-MC and also relates to the interpretation of general

definition in Art 5(1) OECD-MC– In case of subcontracting a PE will only exist if fixed place is at the disposal of main

contractor (new para 10.1 of revised OECD-proposals)• Reference to para 4.2 OECD-Comm of revised OECD-proposals• In the absence of contractor’s employees at site it is necessary to show that contractor clearly

has the effective power to use that site, e.g.– because contractor owns or has legal possession (e.g. lease) of site and – controls access to and use of site

• E.g. enterprise which owns small hotel and subcontracts the on-site-operation of hotel to service provider remunerated on cost-plus basis

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Selected examples of the revised OECD-proposals• Subcontracting all works to another person (para 10 of the Commentary)

– Critical remarks:• Assumption that business of an enterprise may by carried on by third

party without limitation as to whether third party is in any sense dependent on enterprise (contradiction to para 10 Commentary) represents material extension of PE-concept– May pure legal responsibilities be decisive for deeming a PE of main contractor?

• When are premises “at the disposal” of the enterprise if subcontractor is third party and performs services at his premises? – Are subcontractor´s premises automatically deemed to be at the main contractor´s

disposal as subcontractor's activity is assigned to business activity of main contractor?– Or: is effective use (for a long time) of subcontractor´s premises in order to ensure that

he complies with his obligations under contracts concluded with main contractor essential (para 4.3 OECD-Comm)

• Is the subcontractor's “effective power to use the site” automatically attributed to the main contractor?

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• Subcontracting all parts of a construction or installation project to another person (para 19 of the Commentary)– Periods spent by subcontractors to be attributed to general contractor

• Up to now only applicable if part of a project are subcontracted to other enterprises (para 19 OECD-Comm)

– Site at disposal of general contractor during time spent on site by any subcontractor if general contractor has construction site at its disposal by reason of factors such as• Legal possession of the site, • Controls access to and use of the site and • Overall responsibility for what happens at location

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• Subcontracting all parts of a construction or installation project to another person (para 19 of the Commentary)– Critical remarks:

• Limitation of scope by means of enumerated factors?– “Legal possession” regularly attributed to general contractor– “Overall responsibility” is derived from contractual obligation of general contractor and

will regularly be given» Transfer of construction supervision to subcontractor may therefore not avoid PE» Avoidance of taking over “overall responsibility” in case of joint venture?

– Avoiding control over access to site sufficient?

• Subcontractor´s activities not only allocated for time-test purposes but requires that also subcontractor´s functions are allocated to general contractor?– Portion of general contractor’s profit could be taxed by source state without any “people

functions” performed by general contractor at site

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• Joint ventures and partnerships (paras 10 and 19 of the Commentary)

In the case of an enterprise that takes the form of a fiscally transparent partnership, the enterprise is carried on by each partner and, as regards the partners’ respective shares of the profits, is therefore an enterprise of each Contracting State of which a partner is a resident. If such a partnership has a permanent establishment in a Contracting State, each partner’s share of the profits attributable to the permanent establishment will therefore constitute, for the purposes of Article 7, profits derived by an enterprise of the Contracting State of which that partner is a resident (see also paragraph 19.2 below).

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• Place of management (para 12 of the Commentary)

This paragraph contains a list, by no means exhaustive, of examples of places of business, each of which can be regarded as constituting a permanent establishment under paragraph 1 provided that it meets the requirements of that paragraph. As these examples are to read in the context of the general definition given in paragraph 1, the terms listed, “a place of management”, “a branch”, “an office”, etc. must be interpreted in such a way that such places of business constitute permanent establishments only if they meet the requirements of paragraph 1 and are not places of business to which paragraph 4 applies.

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• Additional works on the construction site (para 19.1 of the Commentary)

Work that is undertaken on a site after the construction work has been completed pursuant to a guarantee that requires an enterprise to make repairs would normally not be included in the original construction period. Depending on the circumstances, however, any subsequent work (including work done under a guarantee) performed on the site during an extended period of time may need to be taken into account in order to determine whether such work is carried on through a distinct permanent establishment.

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• Must the activities referred to in para 4 be of preparatory and auxiliary nature? (paras 21 and 23 of the Commentary)

Where the only activities carried on at a fixed place of business are activities to which one of subparagraphs a) to d) apply, the only activity carried on at a fixed place of business, the place is deemed not to constitute a permanent establishment.

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• Does a development property constitute a PE? (para 22 of the Commentary)

Subparagraph a) relates only to the case in which an enterprise acquires the use of facilities for storing, displaying or delivering its own goods or merchandise. Subparagraph b) relates to the stock of merchandise itself and provides that the stock, as such, shall not be treated as a permanent establishment if it is maintained for the purpose of storage, display or delivery. In the context of these subparagraphs, the words “goods” and “merchandise” refer to tangible property that can be stored, displayed and delivered and would not cover, for example, immovable property and data (although the subparagraphs would cover tangible products that include data such as CDs and DVDs).

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• Meaning of “to conclude contracts in the name of the enterprise” (para 32.1 of the Commentary)

The Working Party agreed that … it was not possible to reach a common view on the situation dealt with in the court decisions [Zimmer Ltd. in France and Dell DUF in Norway; note from the author] …

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Excursus: Relevance of later versions of OECD-Commentary for the interpretation of tax treaties

concluded prior to amendment• Relevance of the OECD-Commentary for the interpretation of bilateral

double tax treaties– Commentary as supplementary means for interpretation– Historic interpretation material

• Relevance of later versions of OECD-Commentary for the interpretation of tax treaties concluded prior to amendment– OECD and national tax authorities (e.g. in Germany and Austria) generally in favor of

dynamic interpretation: changes to the Commentary considered to be relevant for interpreting tax treaties concluded before these changes

– German Federal Fiscal Court (BFH) and Austrian Supreme Administrative Court (VwGH) follow static interpretation: reference only to that version of the Commentary that was already available when the bilateral tax treaty was concluded

– Key question regarding practical impact of proposed changes (if adopted in 2014 update): which changes to the Commentary are only of clarifying nature as opposed to those changes causing a difference in substance?

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Thank you for your kind attention!

Dr. Clemens NowotnyLeitnerLeitner GmbH Wirtschaftsprüfer und Steuerberater T +43 732 7093-359F +43 732 7093-814E [email protected]

Oleg KonnovHerbert Smith Freehills, Moscow T +7 495 363 6531F +7 495 363 6501E [email protected]

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Documents

Oleg Konnov, Partner, Herbert Smith Freehills , Moscow Dr . Clemens Nowotny , Partner , LeitnerLeitner , Linz/Vienna