Comments of the Business and Industry Advisory Committee (BIAC) to the OECD on the OECD Public Discussion Draft:

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1 Business and Industry Advisory Committee to the OECD Comité Consultatif Economique et Industriel Auprès de l OCDE Comments of the Business and Industry Advisory Committee (BIAC) to the OECD on the OECD Public Discussion Draft: Proposed Clarification of Article 15 Paragraph 2 of the OECD Model Convention June 30, 2004 BIAC has carefully studied the public discussion draft entitled Proposed Clarification of the Scope of Paragraph 2 of Article 15 of the Model Tax Convention, dated 5 April 2004, proposing amendments to the Commentaries to Article 15 dealing with exclusion from tax of non-resident employees who perform services in a country under specified circumstances. The proposed amendments to the Commentaries address the situation where services are provided through offshore intermediary entities. Our members are generally very sceptical about the proposed modifications. BIAC would appreciate WP1 seriously considering the following comments when it decides on the next steps in finalizing this project. We appreciate the opportunity to be of assistance. Please call upon us if there is a need to clarify our position. Existing interpretation is designed to prevent abuses The existing paragraph 8 of the Commentary to Article 15 was added to the Model in 1992 in order to prevent clear-cut cases of abuse through the so-called practice of "hiring-out of labour". In such cases, taxation in the country where the activity is exercised is avoided by hiring labour from an intermediary established in a third country having an income tax convention with the host country. The existing Commentary gives guidance as to how the competent authorities should deal with such cases, and it lists certain criteria to be used in determining whether or not the 13/15 chaussée de la Muette Paris France Tel. (33) Fax (33) biac@biac.org VISIT OUR WEBSITE

2 - 2 - real employer is the enterprise in the country where the activities are performed (host or source country). The proposed amendments would have profound consequences Acknowledging the difficulty in certain cases in establishing whether or not a person is, in fact, an employee and, if he/she is an employee, which enterprise is the employer (i.e., host/source country enterprise, home/residence country enterprise or a separate enterprise in a third country), OECD proposes, in the draft amendments (new paragraphs 8 and 8.1 to 8. 21), that the formal contractual relationship involved could be disregarded, even in cases where there are no indications of abuses (non-tax motivated transactions). This approach would have profound consequences for employees of enterprises in the services sector. Instead of being regarded as non-resident employees of a nonresident company rendering services on a temporary basis to a client or an affiliate in the other contracting country, such persons would be deemed to be the employees of the company in the such other contracting country (i.e., the source country), and, therefore, they would, if certain objective criteria are met, always be taxable in the source country where they are performing their services. BIAC does not agree that this is the appropriate way this article of the treaty should be interpreted and applied. If countries would follow the new approach, the limitation of Article 15 paragraph 2 would, in most cases, become meaningless. The result noted in the preceding paragraph is clearly demonstrated in examples 3, 4 and 5 in paragraphs 8.16 to 8.21 of the discussion draft. Take the case of a person "hired" by an enterprise in Country A who is temporarily seconded to an enterprise in Country B, which is in the same or a related line of business as the Country A enterprise, to serve there, temporarily, as a specialist rendering his/her specialised services to the client in Country B. Under this interpretation, he/she will be considered to be an employee of the Country B enterprise, if the conditions mentioned in the list of paragraph 8.11 are substantially fulfilled (i.e., Country B bears the responsibility for his work, instructs and controls him and bears the cost of his services, etc.). This is not an uncommon fact pattern in the services sector and, in 2

3 - 3 - particular, for services rendered within a business group, and the new approach of the OECD discussion draft, when adopted, will have a profound cost impact on those enterprises. We also think that the wording in the last part of the new proposed paragraph 8 (" makes it clear that the exception is not intended to apply where the employment services are rendered to an enterprise that is subject to tax in a State ") would restrict the exception of Art. 15 paragraph 2 and are therefore of the opinion that the Commentary should stick to the orginal meaning and the wording of the Model: The exception of paragraph 2 of Article 15 extends that principle (business presence) to the taxation of the employees of such an enterprise whose employment activities are carried on in the other State during a limited presence as per subparagraph (a). Subparagraphs (b) and (c) make it clear that the exception is not intended to apply where the renumeration is paid by, or borne by the employer, who is a resident of the other State, or is borne by a permenent establmishment, which the employer has in the other State. Rendering specialised services should not be converted into an employment relationship where none exists The international business community clearly rejects such an interpretation. Hiringout of personnel for the provision of specialized services, inter alia, represents a very significant type of business arrangement, and its importance will surely increase considerably in the future. In particular within international business groups, employees are very often sent abroad to fulfil certain functions in an affiliated enterprise. An enterprise hires a temporary service and not a specific person, and the employer, therefore, has the choice as to whom he would send. In our understanding, this is a clear indication that no employee-employer relationship should be deemed to exist. The conditions listed in paragraph 8.11, which should guide the tax authorities of two treaty countries in cases in which they do not agree, are the normal rules used in the area of hiring-out of labour and temporary engagements of specialists. There is no 3

4 - 4 - element of abuse in such transactions, which are clearly not tax-motivated (contrary to the situations referred to in existing paragraph 8 of the Commentary). Following this new interpretation, as set forth in the proposed amendments to the Commentaries under Article 15, the taxing jurisdiction of the host/source country (i.e., the country where the services are being rendered) would be considerably extended, without any clear legal basis therefor in the applicable tax treaty. Our members are surprised how casually the OECD discussion draft puts aside well-established principles incorporated in nearly every bilateral tax treaty, and, the proposed approach is based on a rather thin theoretical analysis and examples which are neither clear nor consistent when analysed in detail. What concerns us, in particular, is that this new language, if ultimately incorporated in the Commentary, will be an open invitation to tax authorities in host/source countries to assert their extended tax jurisdiction in relevant cases, and we anticipate that many tax authorities would take advantage of such an opportunity. Comments regarding the examples in the draft The proposed new commentary includes several examples. BIAC has received a good number of comments and questions regarding those examples from its members, and we, therefore, conclude that the situations described and the tax consequences are not very clear if put to the test of reality. We agree, in example 1 and 2, that the final results, in both cases, would appear to point to the sending company as the real employer. We do not concur with the justification in the draft for arriving at the appropriate result, which is applicable irrespective of whether or not the home country entity charges the costs to the host country entity. In example 3, all the facts are not very clear. It is stated that Fco pays a management fee to Eco. Nothing is mentioned regarding a profit element nor the legal basis for the payment. Is it an underlying contract between both companies or is it only a cost transfer from one company to the other? If there exists an effective contract which includes a profit element for the seconder, both countries have to accept the fact that Eco is the employer. Regarding examples 4 and 5, we strongly disagree with the conclusion that the host country company is, in these cases, the real employer. In both 4

5 - 5 - instances, there exist contracts between the entities. These contracts represent the legal basis for the payments made to the home country entity. The conclusion of the draft is based solely on the fact that the host country company is benefiting from the individuals services, since they are integrated into the business of the host country entity. This is certainly not sufficient justification to disregard an existing employeremployee relationship. We also miss a description of a situation which is rather common in practice: for example in the case of an European finance director, employed by say a Dutch company, and located at its European business headquarters in the Netherlands. Such individual might spend significant amounts of time within various European countries, e.g, 70 days a year in the UK, 40 days a year in Germany, 30 days a year in France, etc. The costs involved will be charged out as part of a management charge to the European affiliates. Such a person should be exempt under Article 15. Arguably, this is analoguous to example 2, but it seems to us that such an example, where the work is not of a project nature (all the examples in the draft are of a project nature), would help to clarify the situation. New rules would create uncertainty and disputes Quoting from paragraphs 6.2 of the existing Commentaries to Article 15, we note that the objective and purpose of subparagraphs b) and c) of paragraph 2 are to avoid the source taxation of short-term employments to the extent that the employment income is not allowed as a deductible expense in the state of source... As a justification of such a principle, paragraph 6.2 indicates that imposing source deduction requirements could constitute an excessive administrative burden in such cases. BIAC strongly supports this view. With the increasing incidence of the use of highly skilled persons (usually technicians) to deliver services in the cross-border scenario (employees and independent workers), the OECD should aim to restrict instances where taxing jurisdiction must be shared between home/residence and host/source countries. Moving in the opposite direction, as would be the case if the 5

6 - 6 - draft commentary were adopted, would create, for international enterprises and employees, uncertainties, new risks and new obstacles to the cross-border activities. As discussed in the draft Commentary, it is often a matter of domestic law of each source country to determine whether services rendered within its borders to a local enterprise are provided by a employee of that enterprise or by way of a contract for the provision of services by a separate non-resident enterprise. The resulting determination will, in some cases, govern the manner in which a country applies the tax convention. It was also mentioned that the concepts applied in practice differ considerably, and some countries may adhere to formal legal requirements while others may rely on an economic or factual interpretations (substance-over-form) irrespective of the legalities involved. Under these circumstances, it is evident that conflicts of interpretation and cases of double taxation will increase substantially should the proposed amendments be adopted. To avoid such difficulties, we strongly support the idea that countries provide, in their bilateral treaties, a clause which clarifies the interpretation of the term "employer" or which avoids problems with respect to hiring-out of personnel. In order to avoid a sharing of the taxing rights for short-term assignments, some countries have come to the conclusion that, with respect to the hiring-out of personnel, the provisions of Article 15 paragraph 2 (b) should not apply in a situation where the services are not rendered for a period longer than 183 days (e.g. Art. 15 paragraph 3 German- Austrian DTA of ). Conclusion BIAC takes exception to the proposed interpretation of Article 15 (b) of the Model as well as the examples provided in the discussion draft. We would strongly recommend that the Commentary be amended to recommend inclusion of a clause such as the one mentioned above in the Germany/Austria convention. Such a clause is in line with the object of the treaty (avoidance of sharing of taxing rights for short-term assignments), provides for a solution for conflicts of interpretation of the term "employer", and it gives employers and employees, as well 6

7 - 7 - as the tax authorities, the necessary legal security with regard to the increasingly important practice of hiring-out of personnel for the provision of specialized services. We believe that it is important to reaffirm the original intent behind Article15; i.e., that its purpose is, as far as possible, to exempt the income from short assignments involving work in other countries, where tax treaty relief exists, unless the employment arrangement is clearly abusive. With increasing international mobility, such arrangements, especially within OECD countries, are becoming an everyday occurrence. BIAC does not wish to promote an environment where there is frequent taxation of such short-term assignments, which tax is then subject, in the employee s country of residence to the applicable double taxation relief. This is, broadly, a zero sum game for the authorities, in terms of tax collected, but potentially a substantial administrative burden on business and on the authorities. 7