Splitting up of contracts is a strategy used for artificial avoidance of Permanent Establishment. Action 7 report notes that as a common strategy for avoiding PE through abuse of Article 5(3) of the OECD Model Tax Convention. Article 14 of the MLI provides to curb this abuse explicitly.
Article 14(1) of MLI – Splitting up of Contracts
Paragraph 1 of Article 14 of MLI states that:
- Where the enterprise of a Contracting Jurisdiction carries on activities in the other Contracting Jurisdiction
- at a place that constitutes a building site, construction project, installation project, or other specific project identified in the relevant provision of the Covered Tax Agreement, or carries on supervisory or consultancy activities in connection with such a place, in the case of a provision of a Covered Tax Agreement that refers to such activities,
- and these activities are carried on during one or more periods, in the aggregate, exceed 30 days without exceeding the qualification period of PE referred to in the relevant provision of the Covered Tax Agreement; and
- where connected activities are carried on in that other Contracting Jurisdiction at (or, where the relevant provision of the Covered Tax Agreement applies to supervisory or consultancy activities, in connection with) the same building site, construction or installation project, or other place identified in the relevant provision of the Covered Tax Agreement
- during different periods, each exceeding 30 days, by one or more enterprises closely related to the first-mentioned enterprise,
- these different periods shall be added to the aggregate period during which the first-mentioned enterprise has carried on activities at that building site, construction or installation project, or other place identified in the relevant provision of the Covered Tax Agreement.
The above provision curbs the splitting-up of contracts of construction project contracts between the related or closely related entities to avoid creating a Permanent Establishment in other contracting jurisdictions. The Contracting Jurisdiction shall aggregate such activities relating to the building site, construction, or installation and related activities at the same site/project by closely related enterprises.
Article 14(2) of MLI – Compatibility Clause
Paragraph 2 is the compatibility clause that describes the relationship between Article 14(1) of the MLI and provisions of Covered Tax Agreements. The compatibility clause provides that the splitting-up of contracts rule shall apply in place of or in the absence of provisions in Covered Tax Agreements. It applies to the extent that such provisions address the division of contracts into multiple parts to avoid applying a period about the existence of a permanent establishment for specific projects or activities.
Many treaties feature anti-splitting rules that apply to a wide variety of activities, only some of which may be covered by the provision in Article 14 of MLI. Paragraph 2 of Article 14 of MLI intends to replace those existing rules only to the extent that they relate to the activities described in paragraph 1 and leave those rules intact concerning activities that are not within the scope of paragraph 1. For instance, the same anti-splitting rule is used for a provision relating to construction activities carried on through a fixed place of business and for a provision deeming a permanent establishment to exist in the provision of services that are not tied to a specific place of business.
Article 14(3) of MLI – Reservation Clause
Given that the provisions addressing artificial avoidance of permanent establishment status through splitting-up of contracts are not required to meet a minimum standard, paragraph 3(a) permits a Party to reserve the right for the entirety of Article 14 not to apply to its Covered Tax Agreements.
Few Covered Tax Agreements could contain anti-contract splitting rules that specifically address the exploration for or exploitation of natural resources, and these provisions are frequently carefully negotiated. Paragraph 3(b) of Article 14 of MLI allows a Party to reserve on the application of Article 14(1) only for the existence of a permanent establishment relating to the exploration for or exploitation of natural resources.
Article 14(4) of MLI – Notification Clause
Paragraph 4 of Article 14 of MLI requires each Party (other than a Party that has opted out of the entirety of the Article) to notify the Depositary of whether each of its Covered Tax Agreements contains an existing anti-contract splitting provision that is not subject to a reservation under paragraph 3(b), and if so, the article and paragraph number of each such provision.
Paragraph 1 will replace such provisions to the extent provided in paragraph 2, where all Contracting Jurisdictions to the Covered Tax Agreement have made such a notification. In other cases, paragraph 1 will apply to the Covered Tax Agreement but will supersede the existing provisions of the Covered Tax Agreement only to the extent that those provisions are incompatible with paragraph 1.