Permanent establishments risk in Africa

Permanent establishments risk in Africa EY Africa Tax Conference September 2014

Panel Moderator Charles Makola International Tax EY South Africa Panel Justin Liebenberg International Tax EY South Africa Chinyere Ike EY Nigeria Christopher Kirathe EY Kenya Josephine Banda EY Botswana Page 2

Agenda Global focus on PEs is increasing General PE and Global perspective Provision of services Business travelers or seconded employees Sales through agents and commissionaires Arrangements involving sub-contractors Construction assembly or installation projects Toll or contract manufacturing arrangements Other Way forward Page 3

Tax risk and controversy survey EY 2014 Tax risk and controversy survey Reputation risk BEPS and legislative risk Enforcement risk Operational risk Page 4

EY presence in Africa EY office No EY office, but support available Page 5

General PE and global perspective Page 6

Permanent Establishment (PE) Art. 7(1) of the OECD and UN Model Conventions The business profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. Art. 5(1) of the OECD and UN Model Conventions... a fixed place of business through which the business of an enterprise is wholly or partly carried on. OECD and UN Model Convention Commentaries on Art. 5(1) Three requirements for the existence of a PE 1. Fixed 2. Place of business 3. Business carried on through that fixed place of business Page 7

The PE concept Structure of PE rule under OECD MC Basic rule a fixed place of business through which the business of the Foreign Enterprise(FE) is wholly or partly carried on Construction rule a building site, construction or installation project which exceeds 12 months Agency rule dependent agents having authority to habitually conclude contracts Services rule option provided to countries to include the rule in 2010 update Exclusion Subsidiary Exclusion for certain activities which have a preparatory or auxiliary character Subsidiary, per se, not a PE unless it satisfies any of the specified rules Fixed place used for storage, display, delivery of goods, fixed place used for purchase of goods and collection of information Page 8

The PE concept UN Model Convention (UN MC) Greater emphasis on Source State taxation Lower activity threshold for constituting PE Key deviations in UN MC Additional rule relating to Services PE Construction PE threshold reduced to 6 months Additional rule to cover dependent agent maintaining stock of goods for delivery Preparatory or auxiliary exclusion restricted to use of fixed place for storage or display Page 9

OECD developments OECD revised discussion draft on PE (published in October 2012): Potential broadening of the PE concept Interpretation of at the disposal PE through use of subcontractors an enterprise can carry on business activities in another state, even where such activities are carried on entirely or partly through a subcontractor Proposals not reflected in 2014 update of the OECD Model Tax Convention(OECD MC) BEPS Action Plan: Action 7 proposes to develop changes to the definition of PE to prevent the artificial avoidance of PE status in relation to BEPS, including through the use of commissionaire arrangements and under the exceptions for preparatory and ancillary activities target date: September 2015 G20 Development Working Group on the Impact of BEPS in Low Income Countries, July 2014 Page 10

What is the relevance of changes to the OECD or UN Commentary? Page 11

How to read PE survey results Beware! The in-betweens Looks okay, but the light may change EY PE Survey conducted by EY South Africa Office, 2013 Page 12

PE survey results Static vs dynamic approach Africa Botswana Ghana Kenya Mauritius Mozambique Namibia Nigeria South Africa Tanzania Rest of the world Austria Belgium Canada Finland Germany Greece Norway Turkey UK Dynamic Static Unclear EY PE Survey conducted by EY South Africa Office, 2012 Page 13

Arrangements that frequently give rise to PE challenges Bases for permanent establishment assertions (global parent companies) Provision of services 57% Sales through agents and commissionaires 31% Business travelers or seconded employees 25% Arrangements involving sub-contractors 16% Construction assembly or installation projects 24% Toll or contract manufacturing arrangements 8% Other 11% Page 14

Services PEs Which situations? Country A Country B Fly-in consultant Page 15

Services under the OECD Model Optional provision OECD commentary paragaph 42.23 (optional provision) Notwithstanding the provisions of paragraphs 1, 2 and 3, where an enterprise of a contracting state performs services in the other contracting state: a) Through an individual who is present in that other state for a period or periods exceeding in the aggregate 183 days in any twelve month period, and more than 50 per cent of the gross revenues attributable to active business activities of the enterprise during this period or periods are derived from the services performed in that other state through that individual. Or b) For a period or periods exceeding in the aggregate 183 days in any 12 month period, and these services are performed for the same project or for connected projects through one or more individuals who are present and performing such services in that other state the activities carried on in that other state in performing these services shall be deemed to be carried on through a permanent establishment of the enterprise situated in that other state. Page 16

Subcontracting of services OECD vs UN any differences? Country A Company A Subcontracting agreement Company B Country B Customer 140 days 60 days Services PE? OECD: subcontracting explicitly carved out, unless subcontractor s personnel is supervised, controlled or given directions by the main contractor UN: no such explicit provision; reference to furnishing of services by employees or other personnel Page 17

Statistics Services PEs in recent tax treaties Scope: 1,586 tax treaties concluded between 1 January 1997 and 1 January 2011 Treaties between two UN countries Treaties between a UN and OECD country Treaties between two OECD countries Total UN model services provision 57.74% (399 of 691) 34.87% (242 of 694) 14.92% (30 of 201) 42.3% (671 of 1,586) Optional OECD services provision 0.00% (0 of 691) 0.58% (4 of 694) 2.48% (5 of 201) 0.57% (9 of 1,586) Source: Bulletin for International Taxation, 1/2012 Page 18

The discussion draft Dependent agent PEs (commissionaire) The working party has failed to reach a common conclusion on the Zimmer and (lower court) Dell cases However, the discussion draft proposes to add a new example to Para. 32.1 of the commentary on Art. 5, which provides that: [ ] in some countries an enterprise would be bound, in certain cases, by a contract concluded with a third party by a person acting on behalf of the enterprise, even if the person did not formally disclose that it was acting for the enterprise and the name of the enterprise was not referred to in the contract. Norwegian Supreme Court decision on Dell (2 December 2011): Commissionaire (i.e., Dell Norway) does not constitute a PE of Dell Ireland in Norway Contracts concluded by Dell Norway were not legally binding on Dell Ireland Decision in line with the Zimmer case Page 20

Example Contract manufacturers and dependent agent PEs (DSM, Spain, 2008) Determines quantities, design, etc. DSM Switzerland Roche Spain Supplies goods and performs marketing functions, but no authority to conclude contracts DSM Switzerland and Roche Spain entered into a contract manufacturing and marketing and promotion agreement Roche Spain produces to order, based on instructions of DSM Switzerland DSM Switzerland leases from Roche Spain a small warehouse for temporary storage of goods Findings of the Spanish National Court: Fixed place of business (warehouse), but no PE of itself, as storage is treated as an auxiliary activity No authority to conclude contracts under the marketing and promotion agreement, and thus no dependent agent PE under that agreement alone But DSM Switzerland had a dependent agent PE under the contract manufacturing agreement: The dependent agent clause operates not just when the agent has the authority to contract in the name of the foreign principal, but also when, given the nature of the activity, the agent involves the principal in the business activities of the domestic market. Page 21

What is the risk of PE creation under a commissionaire arrangement (fact pattern similar to Zimmer)? Page 22

PE survey results Commissionaire Africa Botswana Ghana Kenya Mauritius Mozambique Namibia Nigeria South Africa Tanzania EY PE Survey conducted by EY South Africa Office, 2012 Rest of the world Austria Belgium Denmark Finland Germany Greece Norway Turkey Spain High Low Medium Page 23

Commission arrangement Principal Commission payment Invoice for commission Agent Commission arrangement in terms of which the agent renders services to principal for arms length commission The customer deals directly with the principal in respect of the supply of goods or services Goods or services Supply Customer Whether the agent creates a PE tax presence for the principal Page 24

Invoice for supply Initial inquiry and payment for supply Commissionaire arrangement Principal Invoice and commission Remit payment for supply Agent Commissionaire arrangement in terms of which the agent invoices in its own name on behalf of undisclosed principal Commissionaire earns arm s length commission Commissionaire cannot conclude contracts on behalf of the principal Whether the agent creates a PE tax presence for the principal: South Africa Goods or services Supply Customer Kenya Ghana Botswana Page 25

Items to consider in assessing PE exposure Seconded employees vs business travelers Relevant questions for business travelers ( fly-in workers ) Whose business is carried on? What is worker exactly doing? How often does worker travel? How long does worker stay each time? Does worker have office and space at disposal? Activities of the foreign enterprise to be analyzed as a whole Which PE provision may come into play? Fixed place PE? Services PE? Other? Relevance of TP arrangements: Relevance of significant people functions carried on by seconded personnel Potential compliance Registration as taxpayer File a tax return DTA protection and profit attribution Withholding tax on services Page 27

Employee secondment Arrangement Typical options Reimbursement of cost Company A Company B Secondment of employees Salary payment to bank account of employee Option 1 The employee remains formally employed by Company A, but he or she actually performs the business activities of Company B, which is considered his or her economic employer. Option 2 The employee carries on the business activities of Company A, and Company B is not considered to be his or her economic employer. Questions: Would the employee create a PE for Company A under option 1 Would the employee create a PE for Company A under option 2 Page 28

OECD discussion draft Foreign employee secondments and PE creation risks The OECD discussion draft seeks to align the commentary on PEs with the 2010 changes to the commentary on employment incomes (Art. 15): Changes to the commentary on Art. 15 clarify that the formal employment relationship with the nonresident employer can, in certain circumstances, be disregarded, e.g., if it is established that the services performed by a nonresident employee are economically performed in an employment relationship with the local enterprise. Implications for the PE analysis: Where it is established that the nonresident employee is economically employed by a local enterprise, that employee should not be deemed to be carrying on in the other contracting state the business of his formal non-resident employer that could result in the creation of a PE (see option 1). Where that employment relationship is not to be disregarded, the foreign enterprise is still considered to be carrying on business activities in the other contracting state through its employees, and that could potentially result in the creation of a PE (see option 2). Page 29

OECD discussion draft Contractor who subcontracts all business activities An enterprise can carry on business activities in another state, even where such activities are carried on entirely or partly through subcontractors. In that case, a permanent establishment may be found to exist if the conditions under Art. 5 are met: Subcontractors must perform the work of the enterprise at a fixed place of business that is at the disposal of the enterprise for reasons other than the mere fact that these subcontractors perform such work at that location The small hotel is a good example of this Page 31

Subcontracting The small hotel example Country A Country B Subcontracting agreement Company A owns the hotel. Company A Company B Company A rents out hotel rooms through the internet. Internet sales On-site operation of the hotel On-site operation of the hotel is subcontracted to Company B. Company B is remunerated on a costplus basis. Small hotel Unrelated customers Fixed place of business at the disposal of the enterprise? A location is at the disposal where the non-resident s enterprise has an exclusive legal right to use that location and the location is used exclusively for its business. Page 32

Example offshore accomodation Service AB vs Government of Norway (2001) 1 2 Management agreement with the lessee of the rig Brostrom Offshore accomodation Sweden Agreement regarding catering on the rig 3 Norway 4 Agreement on provision of catering services on the rig Rig Physical performance of catering services on the rig Chalk Catering Rostrum entered into a management agreement with the lessee of a rig in the North Sea (Norwegian continental shelf). Rostrum concluded an agreement with Offshore accommodation regarding the provision of catering services on the rig. Offshore accommodation did not itself provide catering services on the rig, but concluded an agreement with Chalk Catering, a Norwegian company. Under this agreement, Chalk Catering physically provided catering on the rig. Court s findings: Offshore accommodation had a PE in Norway: Under the relevant treaty, any offshore activity carried on for 30 days or more constitutes a PE. Although offshore accommodation did not physically perform the services, it was responsible to Rostrum for the quality of services, and was deemed to carry on business. The Court relied on the OECD Commentary on construction PEs (see Para.19 (Art. 5)). Page 33

Where a foreign enterprise operates in your jurisdiction exclusively through subcontractors, would it be considered to be carrying on business in your jurisdiction? Page 34

PE survey results Sub-contracting Africa Botswana Ghana Kenya Mauritius Mozambique Namibia Nigeria South Africa Tanzania Rest of the world Australia Belgium Canada Finland Germany Greece Norway Turkey UK Yes No Unclear EY PE Survey conducted by EY South Africa Office, 2012 Page 35

Would the tax authorities and courts in your jurisdiction accept that there is no construction PE where the time test is not met, regardless of whether or not the construction site would constitute a fixed place? Page 37

PE survey results Construction and project PEs vs fixed place PE Africa Botswana Ghana Kenya Mauritius Mozambique Namibia Nigeria South Africa Tanzania Rest of the world Australia Belgium Canada Finland Germany Greece Norway Turkey UK Yes No Unclear EY PE Survey conducted by EY South Africa Office, 2012 Page 38

Business restructuring Swiss parent ROI 100% Business restructuring (supply chain reorganizations) responds to market needs and increased competition. Typical business restructuring would involve the redeployment of functions, assets and risks within group entities. For example, reducing the functional significance of an entity in a particular jurisdiction, while increasing the commercial importance of a group entity in another jurisdiction. Operating submanufacturing distributor Payment for goods Customers This normally results in a reduced profit potential in a particular jurisdiction with an impact on future profitability. Examples: Manufacturing Supply of goods Conversion of a full-fledged manufacturer into a toll or contract manufacturer Conversion of a full-fledged distributor into a limited risk distributor or commissionaire Page 40

Restructuring case study Manufacturing and sales agreement Swiss parent Operating submanufacturing distributor Manufacturing Sale of goods and invoicing Delivery of goods Customers Payment for goods After restructuring, the Swiss parent entered into two contracts with the operating sub-manufacturing distributor: Manufacturing agreement manufacturing under strict instructions from the Swiss Principal Sales promotion agreement, including lease of warehouse to the Swiss principal Swiss parent sets sales prices and invoices to customers The Swiss parent directly sells the goods manufactured by operating sub to customers Operating sub management reports to the Swiss parent, which has authority to issue directives Operating sub management bound by strict internal governance procedures Only limited budgetary responsibility of operating sub management Page 41

Restructuring PE creation risk Fixed place PE Premises of a converted entity constitutes a PE for the foreign principal? Principal s staff sent to oversee production at contract or toll manufacturer s factory when would they constitute a PE for the principal? Reliance on exceptions for preparatory or auxiliary activities? Dependent agent PE: authority to conclude contracts in the name of the enterprise Contract or toll manufacturer involved in sales? Limited risk distributor or commissionaire considered to be a dependent agent? Delivery agent PE under the UN Model Reliance on exceptions for preparatory or auxiliary activities? Page 42

Business restructurings and at the disposal Enterprise s presence at the location and the activities it performs are key. A location that is owned and used by a supplier or a contract manufacturer not per se at the disposal of the foreign enterprise. A certain location is at the disposal of the enterprise where that enterprise carries on its business activities on a continuous and regular basis at a location that belongs to another enterprise or is used by several enterprises. A location is at the disposal where the nonresident s enterprise has an exclusive legal right to use that location and the location is used exclusively for its business. Page 43

Example Analysis of the exceptions under the OECD and UN Models OECD Model Art. 5(4) UN Model Art. 5(4) [ ] b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise [ ] f) the maintenance of a fixed place of business solely for any combination of activities mentioned in sub-paragraphs a) to e), provided that the overall activity resulting from this combination is of a preparatory or auxiliary character [ ] b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage or display c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise [ ] f) the maintenance of a fixed place of business solely for any combination of activities mentioned in sub-paragraphs a) to e), provided that the overall activity resulting from this combination is of a preparatory or auxiliary character Page 44

Concept of delivery (X Ltd vs APEH, Hungary, 2008) Goods Goods UK Co Hungarian branch Hungarian Co Hungarian Supreme Court opinion interpreting the UK- Hungary double tax treaty UK company held a branch in Hungary through which it sold goods to a related Hungarian company, which then sold them on to unrelated customers UK company argued it was only keeping goods in Hungary for the purpose of storage, display and delivery Findings of the Hungarian Supreme Court Held that the UK company had a PE because: It resold the goods to another person Goods Unrelated customers It issued invoices in the name of the Hungarian branch and The branch s corporate registration stated that its activities included the distribution of goods Page 45

Other Time limits Page 47

OECD discussion draft Time limits for (fixed place) PE creation Six-month period as a general rule applied by most countries No changes to commentary proposed in discussion draft Exceptions to the six-month rule: Recurrent activities Business carried on exclusively in the source state one-shot projects Discussion draft proposes to add two examples to illustrate these exceptions Implications for special purpose vehicles in general? In the context of construction and project PEs? Page 48

Would the tax authorities in your jurisdiction consider that the time requirement for the creation of a permanent establishment is met where a business project is wholly carried on in your jurisdiction, although it lasts only for 4 months? Page 49

PE survey results One shot projects Africa Botswana Ghana Kenya Mauritius Mozambique Namibia Nigeria South Africa Tanzania Rest of the world Australia Belgium Canada Finland Germany Greece Norway Turkey UK Yes No Unclear EY PE Survey conducted by EY South Africa Office, 2012 Page 50

Way forward Page 51

Where should taxpayers head from here? Planning Implementation Dispute resolution Page 52

Where should taxpayers head from here? Planning Implementation Dispute resolution To avoid unpleasant PE surprises, make sure that your facts are aligned with what is happening on the ground. Review all inbound services performed by foreign companies in order to determine the extent of PE exposure. Determine whether the foreign entity has corporate income tax exposure in local countries by virtue of source or other domestic law criterion. Establish whether the foreign entity needs to register for income tax and file a tax return in local jurisdiction. Review availability of financial data and other information used to compute profit allocations. Develop high-standard documentation in a wider range of countries than ever. Be prepared to rely on other channels of resolution, including those you may not have considered to date, such as Voluntary Disclosure Programme and Settlement. Keep in mind the reputational risk that the public debate may generate and engage in a dynamic way with internal and external stakeholders to minimize the possibility of unfavorable outcomes. Page 53

Questions Page 54

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