Your Taxes: Exporters beware of sales agents

On October 5 the OECD published recommended measures that purport to tackle BEPS – Base Erosion Profit Shifting.

Exporters around the world need to take note of the latest recommendations of the OECD. Any business that uses overseas agents or warehouses should take note.

A company resident in country A may be taxed on its income in country B if it does business via a permanent establishment in country B. A PE is a fixed place of business or a dependent agent.

Paying tax in another country because of a PE can be a nuisance, even if tax there is creditable against home country tax. This is in addition to import duties and value-added tax sometimes.

In recent years, multinationals have been making sales over the Internet, often using offshore companies. As a result, importing countries have found their tax bases shrinking.

So the OECD was commissioned to tweak the PE rules. Israel joined the OECD in 2010.

On October 5 the OECD published recommended measures that purport to tackle BEPS – Base Erosion Profit Shifting.

However, these rules are like using a sledgehammer to crack a nut. They will hit almost all businesses engaged in international trade even if they are innocent start-ups.

Action 7 is the BEPS report that addresses the PE issue (“Preventing the Artificial Avoidance of Permanent Establishment Status”).

OECD recommendations regarding sales agents:

The OECD says that a taxable PE will exist if a person (=agent) is acting in a country on behalf of another enterprise (=exporter) and either: (1) habitually concludes contracts, or (2) habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by that enterprise.

The above applies if the contracts are: (a) in the name of the enterprise, or (b) for the transfer of the ownership of, or right to use property owned or used by the enterprise, or (c) for the provision of services by that enterprise.

What is a principal role? Convincing the customer to enter into the contract, according to the OECD.

These are dramatic changes. Until now, a PE was avoided by saying an agent cannot bind the exporter’s without the exporter’s approval. But an agent will now trigger a PE for the exporter if the agent habitually concludes OR plays a principal role convincing clients to sign.

In real life, local agents do convince clients to sign, especially if they are in a different time zone to the exporter, as they are in closer proximity to the client, speak the same language and share the same culture.

So thanks to the OECD, agents may soon be out of favor, and other trading solutions will be needed.

OECD recommendations regarding independent agents:

The above rules regarding agents will not apply to independent agents acting in the ordinary course of their business. This was always the case, but the OECD recommends that the meaning of “independent agent” be tightened up.

Going forward, the OECD says an agent will not be an independent agent if it acts exclusively or almost exclusively on behalf of one or more enterprises (=exporters) to which it is closely related, i.e. where one controls over 50 percent of the voting power and value the other, or both are under common control to the same extent.

This matters, because many exporters use local subsidiary companies to act as their sales agents – until now they were considered independent agents if they couldn’t bind the exporter.

Therefore, many exporters and their lawyers will need to consider amending intercompany sales agency agreements, otherwise the agent is likely to constitute a taxable PE for the exporter.

Moreover, if the exporter and agent are not closely related, a party may still be a dependent agent (i.e. a PE of the exporter) in many other cases according to the OECD. These cases include: • Employee; • Partner; • Activities are performed exclusively or almost exclusively on behalf of one enterprise (=exporter) or closely related enterprises; • Control over the manner in which the work is carried out, including detailed instructions as to the conduct of the work (but special skill and knowledge of the agent indicate independence); • Conducts business unrelated to the business of the agent; • Insurance company collects premiums through the agent, subject to any relevant tax treaty.

OECD recommendations regarding warehouses:

Until now, a warehouse was generally excluded from the definition of a PE. A PE will now include most warehouses unless they are preparatory or auxiliary in nature. This is aimed at online traders in one country with a warehouse in another country even if they don’t have an agent. It is also aimed at consignment basis trading – passing ownership to a local dealer at the last minute when the dealer makes an onward sale to a local customer. It is not aimed at bonded warehouses.

Auxiliary or preparatory means remote from the actual realization of profits. The decisive criterion is whether or not the activity itself forms an essential and significant part of the activity of the enterprise as a whole. A preparatory activity will often be carried on during a relatively short period. It is unlikely that an activity that requires a significant proportion of the assets or employees of the enterprise could be considered auxiliary.

Other OECD recommendations:

The OECD clarifies that a toll manufacturer may not trigger a PE if the principal is merely a distributor and other conditions are met. This will be good news for “fabless fabs” and other businesses that use Asian or other toll manufacturers to make products for them to distribute.

Purchasing offices used to be excepted from the definition of a PE. Now the OECD says the PE exception will not apply if the goods are sold onwards, rather than used by the enterprise.

A foreign news bureau may be excepted from the definition of a PE if it does not engage in any advertising activities, according to the OECD.

The OECD also proposes new PE rules to avoid the fragmentation of taxable long term construction and assembly projects into a series of short term projects via different companies and/or different contracts. This is a separate topic.

Implementation date?

In principle, the OECD recommendations necessitate amendments to bilateral tax treaties.

But this process may be jump started by a multilateral treaty on the way, or even sooner if a tax authority considers it is permitted to disregard tax anti-avoidance. The OECD refers to this as soft law….

Comments:

The OECD changes may game changers for many international businesses. If a PE is accidentally (or deliberately) triggered, the OECD has promised to issue detailed guidance on how much profit to attribute to the PE – this is expected next year. Exporters and others involved in international commerce should monitor the changes, review their contracts, amend their business model and check their worldwide tax situation. As always, consult experienced tax advisers in each country at an early stage in specific cases.