Permanent Establishments: Always something to keep you on your toes

Tax experts who were planning their summer holidays in the Northern Hemisphere could possibly have taken the OECD discussion draft of 5th July, 2016 as part of their summer holiday reading material.

The section referred to discusses the acknowledgement of profits attributed to permanent institutions. It is just 40 pages in length in which over 50 people and companies submitted their comments.It was published by the OECD on the 9th September, 2016 and totaled over 400 pages in the draft form. Apart from one solitary submission, all the rest were from the Northern Hemisphere.

Branch disparity configurations

On top of the above there was even more to take into account over the summer, when, on 22nd August 2016, the OECD then published a Draft for Public Discussion on Branch Disparity Configurations, which was a follow up to their previous work on BEPS Action 2 (Neutralizing the Effects of Hybrids Disparity Structures). While Parisians were all away on holiday, 2 rue Andre Pascal were as busy as bees.

Branch disparities happen when the home office and branch authorities disagree on the distribution of income and overheads between the branch and head office. Also included are instances when the head of the branch does not acknowledge the taxpayer as having a taxable presence in that particular area. The OECD is worried that by taking advantage of such disparities it could ultimately produce the identical results that are focused on in the BEPS Action 2 Final Report.

Disparity Types

There are five basic types of disparity deals which are discussed in this document and that are particular to branches. These are listed below:

· The branch office does not recognise a permanent establishment (PE), or other taxable presence in that particular area of jurisdiction.

· The branch area of jurisdiction does recognise the branch but a payment which is payable to the branch, is in fact credited to the head office. At the same time, the head office claims the payment is exempt from taxation because the payment was in fact made to the branch.

· It is shown that the branch has made a hypothetical payment to the head office, this results in a disparity for both the head office and branch under the laws of their jurisdictions.

· This identical expenditure creates a withdrawal for both the branch and head office jurisdictions and:

· The payee counterbalances the income from a deductible source against a withdrawal which arose as a result of a branch disparity situation.

The discussion employs numerous instances of disparities or mismatches which suggest planned configurations. This implies that a scheme is in place which totally disregards branch structure. As such, a deductible payment received by a taxpayer is regarded as by the head office as being made to a foreign branch. This entitles the payment to be eligible for foreign PE exemption, whereas the branch jurisdiction does not recognise the existence of the branch. Consequently the payment is not subjected to any taxation. To illustrate an instance: if a Luxembourg company receives royalty payments which by the laws of Luxembourg could be ascribed to a permanent establishment in the United States but in fact under U.S. law no branch or PE even exists. The EU Commission’s State Aid investigation into MacDonald’s was established upon the above instances. (SA.38945 Alleged aid to MacDonald’s–Luxembourg).

The “diverted branch payment” is yet another variation of this illustration. In this instance the payment is ascribed to a different section of the venture by the laws of the state of residence or head office and the state of the branch. The discussion draft suggests restricting the range of the branch involvement to exclude payments that are not included in the tax base of that branch thereby making them subject to tax rule as opposed to exemption. Then again, no deduction should be set for a payment which could result in a disparity in which it is doubly non-taxable. In actual fact, no branch is “disregarded” – usually it merely does not exist under the tax laws of one state, even if it does under the tax laws of another state. In this way the payments are not “diverted” from one section of the venture to another, each state considers the attribution of the payment in a different way.

Consultation Questions

Questions for consultation are not fully addressed in the Draft, especially with regard to disparities between national tax systems. For example, which state should tax the payment which benefits from double taxation? What makes a disparity acceptable or unacceptable? In fact, consultation questions only give rise to whether specific disparity prevention regulations should be applied to payments made under specific agreement or between members who belong to the same jurisdiction.

At the end of the day, the outcome of the OECD effort will result in precise recommendations to improve national law which will in turn, address the above concerns. If this is the case, the EU Member states will need to take heed but other states may disregard the recommendations. On 19th September, 2016 the European Commission made an announcement that there would be an in-depth state aid into Luxembourg rulings on tax handling of zero interest convertible loans in the GDF Suez group (now Engie). These methods created deductible interest outlay for the borrower whereas the lender incurred no income inclusion on conversion of the loans to shares. (Case No. SA.44888: European Commission Press Release I/16/3085). The Commission regards this as inconsistent application to national law which in turn creates double non-taxation as seen in the MacDonald’s ruling.

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