A country has a right to tax the income of its residents and the income of PE of non-resident MNEs. However, through a web of tax planning and corporate structures, many large corporates have artificially avoided the establishment of PE through Commissionnarie Arrangements (covered in Article 12 of MLI) and similar strategies. An OECD study Addressing Base Erosion and Profit Shifting (BEPS) finds that some multinationals use strategies that allow them to pay as little as 5% in corporate taxes when smaller businesses are paying up to 30%.
PE through Commissionnarie Arrangements
“Notwithstanding the provisions of a Covered Tax Agreement that define the term “permanent establishment”, but subject to paragraph 2, where a person is acting in a Contracting Jurisdiction to a Covered Tax Agreement on behalf of an enterprise and, in doing so, habitually concludes contracts, or habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise, and these contracts are:
a) in the name of the enterprise; or
b) 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
c) for the provision of services by that enterprise,
that enterprise shall be deemed to have a permanent establishment in that Contracting Jurisdiction in respect of any activities which that person undertakes for the enterprise unless these activities, if they were exercised by the enterprise through a fixed place of business of that enterprise situated in that Contracting Jurisdiction, would not cause that fixed place of business to be deemed to constitute a permanent establishment under the definition of permanent establishment included in the Covered Tax Agreement (as it may be modified by this Convention).”
Paragraph 1 of Article 12 has a non-obstante clause. It overrides the provisions of the definition of PE term given under the CTA but is subject to exclusion from Paragraph 2 of Article 12 to the independent agents.
To curb artificial avoidance of PE through Commissionnarie Arrangements, Paragraph 1 of Article 12 deems the existence of a PE if:
- A person is acting in a Contracting jurisdiction (State of PE) of CTA
- On behalf of an enterprise (State of Residence of the enterprise)
- And habitually concludes contracts or habitually plays the principal role in the conclusion of contracts without material modifications from the enterprise,
- And these contracts are 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.
When Article 12(1) of MLI is triggered, the PE is established in the Contracting Jurisdiction (State of PE) for any activities that the person mentioned above undertakes for the enterprise. An exception to this is Paragraphs 4 and 5 of Article 5 of the OECD Model Tax Convention regarding the exclusions and fixed base PE.
Paragraph 2 of Article 12 of MLI – Independent Agent
“Paragraph 1 shall not apply where the person acting in a Contracting Jurisdiction to a Covered Tax Agreement on behalf of an enterprise of the other Contracting Jurisdiction carries on business in the first-mentioned Contracting Jurisdiction as an independent agent and acts for the enterprise in the ordinary course of that business. Where, however, a person acts exclusively or almost exclusively on behalf of one or more enterprises to which it is closely related, that person shall not be considered to be an independent agent within the meaning of this paragraph with respect to any such enterprise.”
Paragraph 2 of Article 12 of MLI represents the provisions relating to independent agent exemption recommended under Final Report on BEPS Action 7. According to Paragraph 2 of Article 12 of MLI, Article 12(1) provisions will not apply to an independent agent representing the enterprise of other contracting jurisdiction in an ordinary course of business. However, when such a person works exclusively for two or more enterprises to which it is closely related, that person shall not be considered an independent agent for Paragraph 2 of Article 12 of MLI.
Paragraph 3 of Article 12 of MLI – Compatibility Clause
Paragraph 3 is a compatibility clause that describes the interaction between paragraphs 1 and 2 provisions on PE through Commissionnarie Arrangements and provisions of Covered Tax Agreements. Existing tax treaties may include a wide variety of such provisions.
Paragraph 3(a) provides that paragraph 1 of Article 12 of MLI would replace existing provisions of a Covered Tax Agreement on dependent agent permanent establishment. However, it applies only to the extent that such variations address the situation in which a person has, and habitually exercises, an authority to conclude contracts in the name of an enterprise.
Paragraph 3(b) provides that paragraph 2 of Article 12 of MLI would replace provisions of a Covered Tax Agreement that provide that an enterprise shall not be deemed to have a permanent establishment in a Contracting Jurisdiction regarding an activity which an agent of an independent status undertakes for the enterprise.
Paragraph 4 of Article 12 of MLI – Reservation Clause
Given that provisions addressing artificial avoidance of permanent establishment status through commissionnaire arrangements and similar strategies are not required to meet a minimum standard, paragraph 4 allows a Party to reserve the right not to apply the entirety of Article 12 to its Covered Tax Agreements.