BEPS Action Plan 7 Preventing the Artificial Avoidance of Permanent Establishment Status Prepared by: Jalaj Gupta Head – International Tax SP Chopra & Co.

Brief background of Permanent Establishment The document, Preventing the Artificial Avoidance of Permanent Establishment Status (the Action 7 Report or Final Report), provided changes to the permanent establishment (PE) definition in Article 5 of the OECD Model Tax Convention (MTC) to prevent the use of the several arrangements that were considered to enable a foreign enterprise to operate in another country without creating a PE and hence avoiding tax. Aim of Action Plan 7: Develop changes to the PE definition to prevent the artificial avoidance of PE status. PE, its taxability and avoidance have always raised divergent views. With the passage of time, keen minds evolved and implemented myriad ways for MNEs to conduct businesses and allegedly also exploited non-transparent loopholes and mismatches in global tax rules and hence avoided PE status. In order to address such tax planning strategies and to ensure that the source states do get their due share of taxes, the BEPS project was initiated and the 15 Action Plans were released by the OECD/G20 countries.

BEPS (Base Erosion Profit Shifting) Basic understanding BEPS : BEPS refers to tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity, resulting in little or no overall tax being paid A group of twenty - ‘G20’ countries realized the need of preventing BEPS and approached OECD to address the issue related to BEPS. BEPS Action Plan : OECD has issued 15 action plans to address BEPS in a comprehensive and coordinated way which will result in fundamental changes to the international tax standards. While the OECD steps up its efforts to address double non-taxation, it will also continue to work to eliminate double taxation.

Articles under OECD MTC with respect to PE Articles as per OECD MTC Summary Article 5(1) Basic definition of PE Article 5(2) What PE specifically includes – like branch office Article 5(3) A building site or construction or installation project constitutes a permanent establishment only if it lasts more than twelve months Article 5(4) Exclusions i.e. the term PE shall be deemed not to include - activity of a preparatory or auxiliary character Article 5(5) An agent/ commissionaire of dependent status— is acting on behalf of an foreign MNE and habitually exercises an authority to conclude contracts in the name of foreign MNE Article 5(6) Broker, general commission agent or any other agent of an independent status

BEPS Action Plan 7 – Changes in Article 5(5) and 5(6) BEFORE Actual conclusion of contracts required to create a PE Person (other than of independent status) acting on behalf of a foreign MNE AFTER Foreign principal deemed to have a PE when a person acting on its behalf habitually concludes contracts or habitually plays the principal role leading to the conclusion of contracts and no material modification by the principal Changes in Article 5(6) BEFORE Depending on the facts and circumstances, an agent acting on behalf of a related enterprise could be considered to be an independent agent AFTER A person acting exclusively or almost exclusively on behalf of one or more enterprises to which it is closely related* shall not be considered to be an independent agent. *”Closely related”, if it possesses at least 50% of the beneficial interests in the other or, if a company, at least 50% of the aggregate vote and value of shares of the company or the beneficial equity interests.

Practical example - Changes in Article 5(5) and 5(6) Live project – Marketing/ Sales Support Service (MSS) I Co Subsidiary Customers G Co MSS services Payment of commission Outside India India Sale Facts G Co selling products to third party customers in India. I Co provides MSS to G Co by dealing with customers, negotiating sales contracts and accepting purchase orders and is the exclusive point of contact for foreign customers. Current scenario The sales agents and commissionaires create a PE when it concludes contracts in the name of the principal. Going forward Potential PE risk in Negotiating elements of a contract in a way that is binding on the principal convincing the customer to enter into a contract with the principal (“playing the principal role leading to the conclusion of contracts”)

BEPS Action Plan 7 – Changes in Article 5(3) Before Construction-type activities carried out under separate contracts by different companies do not create PEs as long as each contract does not exceed 12-month threshold. PE may be deemed to exist if contracts are concluded with a principal purpose of claiming an exemption under Article 5(3). It would be necessary to evaluate the activities carried on by one or more closely related enterprises at the same building site, construction or installation project to determine whether they are connected activities that should be aggregated. After

Practical example - Changes in Article 5(3) Project duration 22 months Submitted successful bid for construction project G Co Construction company Sub Co XYZ Contract for 11 months Outside India India Contract for 11 months 100% subsidiary PO

BEPS Action Plan 7 – Changes in Article 5(4) The term “permanent establishment” shall be deemed not to include: the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise; the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery; the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise; the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise; Auxiliary: carried on “to support, without being part of, the essential and significant part of the activity of the enterprise as a whole” Preparatory: carried on in contemplation of “essential and significant part of the activity of the enterprise as a whole” Art. 5(4) Activities listed under Art. 5(4) to be exempted only if they are of a preparatory or auxiliary character

Thank you Prepared By JALAJ GUPTA Head – International Tax SP Chopra & Co. # +91 98111 93626 # +91 11 23313 495-6-7 Email: jalajgupta@spchopra.com