In Part 3 of the Permanent Establishment (PE) series, we will deal with Paragraphs 5 to 8 of the OECD Model Tax Convention. The paragraphs deal with the applicability of the PE for entities represented by Person acting as an agent/representative in another state.
Paragraph 5: Dependent Agent creating Permanent Establishment
Paragraph 5 provides the conditions for the existence of a Permanent Establishment another state when a person represents the entity. The Person representing foreign enterprise creates Permanent Establishment if he undertakes the contract on behalf of the enterprise. It includes being a principal negotiator in the conclusions of the contracts without material alterations by the Principal. The contract should have the following feature:
- The contract is under the name of the foreign enterprise
- The contract is regarding the transfer of ownership, Or
- Rights to use of the property of the enterprise, Or
- For the provision of services by that enterprise.
The enterprise will not be a Permanent Establishment if the Person provides these services through a fixed place and which are of preparatory or auxiliary nature, as mentioned in Paragraph 4 of Article 5.
How to identify whether a person is acting on behalf of an enterprise?
While ‘acting on behalf of an enterprise’ actions of a person will involve the enterprise in doing business in foreign State. And the action of the Person will impact the enterprise directly or indirectly.
An example of such a relationship would be Employee acting for Employer, Partner acting for Firm, and an Agent for the Principal.
What does the phrase “Concludes contract” represents?
Every country has legislation enforced to verify when a contract exists in the country. The domestic law of a country will determine the nature or type of agreement that is treated as a Contract. It can be a written or oral agreement. Some countries will interpret the contract to be in force if it pertains to actions or resource of the State, even if the contract is signed outside the State,
So, in the context of Paragraph 5 of Article 5, the Person is said to be concluding the contract, based upon the domestic laws of the countries. Also, when a person negotiates the entire contract and terms and conditions, but the contract is signed outside the State by a third person, then the contract will be said to have done in the State.
What is the phrase “or habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise?
The phrase attempts to include the transactions or arrangements where a person undertakes the negotiations and concludes the final terms and conditions of the transactions. The final transaction is undertaken by that third party and enterprise, without any changes.
Illustration: Mayo, a nonresident of the USA, visits New York for 30 days. He meets people and his friends from the food processing center to show the new variant of instant noodles made in Italy. For the companies and retailers who wish to buy the packets, he provides the terms of the agreement and minimum order and final price. After final negotiation, buyers receive a contract via email in the next 15 mins, from ABC Inc of Italy, who is the manufacturer of the product. Buyer sign and agree upon the contract and remit funds. Mayo leaves New York and goes to his home in Barcelona. He receives the commission from ABC Inc for the sales made in the USA. Assuming Italy and the USA have adopted the OECD Model Tax Convention, a Permanent Establishment exists in New York for ABC Inc.
What if, in the above case, Mayo was the distributor, and he agreed in New York for the stocks he had with him? In that case, the conditions of Paragraph 5 do not meet. Hence there won’t exist a Permanent Establishment for ABC Inc.
Paragraph 6: Independent Agent
Paragraph 6 of Article 5 states that paragraph 5 will not apply for an Independent Agent. An independent agent is a person acting on behalf of an enterprise in the ordinary course of business. He does not operate exclusively to one or more enterprises to which it is closely related.
Illustration: Mrs. Jinkins is a wholesaler in State A. She imports the products from different countries and maintains a unique collection of merchandise. She is not closely related to any foreign enterprise. In such a case, she will not become Permanent Establishment for any of her vendors.
Paragraph 7: Impact of having a closely related party with Permanent Establishment.
Paragraph 7 of article 5 clarifies that the existence of Permanent Establishment for any closely related entity does not deem to be a Permanent Establishment for the other entities.
Illustration: Maxi Inc, a company from the USA, controls Dexter LLC in Italy. Dexter LLC has a permanent establishment in Germany, and Maxi Inc has a showroom for displaying the products in Berlin. Does the existence of Permanent Establishment of Dexter LLC in Germany, deem the presence of Permanent Establishment for Maxi Inc? Assuming all three countries have adopted the OECD Model Tax Convention.
No. As per Paragraph 7, there will not be a Permanent Establishment for Maxi Inc in Germany.
Paragraph 8: Defining a closely held enterprise.
Paragraph 8 of Article 5 defines Closely related entities.
The closely related entities form when one or more entities control the other entities. When will an entity have a controlling interest? When one enterprise holds more than 50% of the beneficial interest of other entities, it is said to be a controlling enterprise. Owning a beneficial interest could be done through multiple complex arrangements. Hence it is required to check the facts.