And the risks of doing business globally under the TCJA and BEPS
Both the Tax Cuts and Jobs Act (TCJA) and base erosion and profit shifting (BEPS) has multinationals assessing the taxability of their global profits. The Organization for Economic Cooperation and Development (OECD) made it clear: Taxing jurisdictions will look to the potential expansion of permanent establishment (PE) rules under Action 7, “Preventing the artificial avoidance of permanent establishment status,” to bolster tax revenue in their countries. Additionally, new U.S. international tax rules under the TCJA are consistent with the OECD’s recommendations under BEPS (e.g., hybrid disallowance rules, anti-deferral of controlled foreign corporation income and the new interest expense limitation) and will require companies to evaluate the risks in doing business abroad. This article addresses some of the risks of doing business offshore and being classified as a permanent establishment.
US multinational corporations doing business in foreign countries (and foreign based multinational corporations doing business inside the US or foreign countries other than their own) are typically subject to the domestic tax laws of the countries where they engaged in business activities. However, if the corporation’s home country has entered into a tax treaty with the target country, the treaty will typically provide a higher threshold for taxation than the domestic tax laws applicable in the target country. That higher threshold is commonly referred to as a permanent establishment (PE). Following is a brief discussion of the rules that govern the determination of PE under generic treaty language.
Baker Tilly International has introduced PE Tracker: a mobile tool designed to manage permanent establishment (PE) risks. Let us help you answer the question: “PE or not PE?” by downloading the latest version of Tax Mapp
As mentioned above, where a corporation’s home country has entered into a tax treaty with a target country, the business operations of the home country corporation are protected from target country taxation as long as those activities do not create a PE in the target country. Typically, a tax treaty defines a PE using the following two general tests:
- Whether the corporation has a fixed place of business within the target country, as defined under the language of a specific treaty
- Whether the corporation operates in the target country through a dependent agent that habitually exercises the authority to conclude contracts on behalf of the corporation in the target country
Note that the definition of a PE is typically similar under both the Organization for Economic Cooperation and Development (OECD) model treaty standard language and US model treaty standard language. However, a specific treaty should always be examined for exceptions or differences from standard language.
Fixed place of business
Under the first prong of the PE test outlined above, a corporation must operate in a target country through a fixed place of business to create a PE. A fixed place of business has been defined to include the following types of physical locations:
- Place of management
- Branch or an office
- A mine, oil, or gas well, quarry, or any other place where natural resources are extracted
However, there are exceptions to these general types of locations that do not constitute a PE for treaty purposes. The exceptions are as follows:
- Use of a facility solely for the purpose of storage, display, or delivery of goods or merchandise owned by the corporation
- Maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purposes of storage, display, or delivery
- Maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise
- Maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise (or collecting information) for the enterprise
- Maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other preparatory or auxiliary activity
- Maintenance of a fixed place of business solely for any combination of the activities listed above
Based upon the foregoing, a corporation has many options for doing business in a target country without triggering a PE for treaty purposes. The analysis is highly fact-specific for each case, and the treaty language may vary depending upon the two countries involved in the analysis.
Using target country sales agent
A PE may also be created in a target country if a corporation operates in that country through a dependent agent. Typically, treaties will provide the following general language addressing the use of agents in a target country:
An enterprise of a contracting state shall not be deemed to have a permanent establishment in the other contracting state merely because it carries on business in that other contracting state through a broker, general commission agent, or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business. However, when the activities of such an agent are devoted wholly or almost wholly on behalf of that enterprise, he/she will not be considered an agent of an independent status within the meaning of this paragraph if it is shown that the transactions between the agent and the enterprise were not made under arm’s-length conditions.
Typically, the analysis to determine whether an agent is working as an independent agent can be determined by examining whether the agent is:
- Acting in the ordinary course of their business
- Economically independent from the home country corporation that has contracted for their services
- Legally independent from the home country corporation that has contracted for their services.
Further, when examining the agency relationship, it is helpful to also identify the category of the agent that has been hired by the home country corporation. For example, agents can be considered any one of the following:
- An importer or distributing agent
- A general sales commission agent
- A consignment agent
Each type of agent must always be operating in the ordinary course of their business – and must meet the economic and legal independence tests to protect the home country corporation from being considered as operating a business through a permanent establishment in the target country. In all cases, consideration of the issues discussed above must be made when any client or potential client is expanding their operations into a foreign country.
If you would like more information on this topic or have questions please contact your Baker Tilly advisor or send an e-mail to firstname.lastname@example.org.