Bloomberg Tax
Oct. 28, 2021, 7:00 AM

Permanent Establishment and Business Restructuring

Annabelle Bailleul-Mirabaud
Annabelle Bailleul-Mirabaud
CMS France
Julie  Vergnes
Julie Vergnes
CMS France

According to the Organization for Economic Cooperation and Development (OECD) Transfer Pricing Guidelines, business restructuring refers to the cross-border reorganization of the commercial or financial relations between associated enterprises, including the termination or substantial renegotiation of existing arrangements (Section 9). It may aim at maximizing synergies and economies of scale, improving the efficiency of the supply chain, taking advantage of the development of certain technologies or at preserving profitability or limiting losses.

When the business restructuring involves entities operating in different jurisdictions, tax issues often arise. Among these, the question of the recognition of a permanent establishment (PE), and the attribution of profit to such PE, became one of the most significant areas of dispute between tax authorities and taxpayers.

The concept of PE was first defined in 1958 in the Organization for European Economic Cooperation (OEEC) report as a threshold test that gives rise to income tax liability in a particular jurisdiction. (In certain cases, this may also in practice lead to a value-added tax liability.) Such concept was then incorporated into Article 5 of the OECD Model Tax Convention which has been modified in the last instance in 2017 following the base erosion and profit shifting (BEPS) project, in order to broaden it.

Under Article 7 of the OECD Model Tax Convention, a contracting state cannot tax the profits of an enterprise of the other contracting state unless it carries on its business through a PE situated therein (Commentary on Article 5 of the OECD Model Tax Convention).

Under Article 5 in its current version, a PE arises in a contracting state where (i) an enterprise of another contacting state has in the former “a fixed place of business through which the business of an enterprise is wholly or partly carried on,” or where (ii) “a person is acting in the former on behalf of the enterprise and, in doing so habitually concludes contracts, or habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise, and these contracts are a) in the name of the enterprise, or b) for the transfer of the ownership of, or for the granting of the right to use, property owned by that enterprise or that the enterprise has the right to use, or c) for the provision of services by that enterprise.”

A 12-month duration threshold is provided for building sites or construction or installation projects.

The article specifies that the “person acting in a Contracting State on behalf of an enterprise of the other Contracting State carries on business in the first-mentioned State as an independent agent and acts for the enterprise in the ordinary course of that business” does not constitute a PE. “Where, however, a person acts exclusively or almost exclusively on behalf of one or more enterprises to which it is closely related, that person shall not be considered to be an independent agent within the meaning of this paragraph with respect to any such enterprise.”

In paragraph 4, Article 5 of the OECD Model Tax Convention provides for the following list of exceptions to the PE concept:

  • 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;
    • 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;
    • for the purpose of carrying on, for the enterprise, any other activity;
    • for any combination of activities mentioned in subparagraphs a) to e), provided that such activity or, in the case of subparagraph f), the overall activity of the fixed place of business, is of a preparatory or auxiliary character.

In the framework of business restructurings, the use of this concept has been, and is, key for groups to determine where and how they redeploy their functions, risks and assets.

Use of PEs in International Business Restructuring

The use of the PE concept could lead to a taxable presence in a territory where a foreign enterprise does have a physical establishment or other forms of presence in that country, depending on the circumstances.

Starting in the 1990s, multinational groups often reorganized their activities based on the previous version of Article 5 of the OECD Model Tax Convention which gave a strict definition of a PE and its exceptions. For instance, in relation to distribution activities, they usually chose agents who had no authority to conclude contracts in the name of the parent company, or commissionaires who were independent, to avoid having a PE in the source country.

Following the same idea, as regards construction, installation or building projects, the contracts were split up among different parties so that the duration of each contract remained below the time limit provided under the definition of a construction PE.

Groups also used to divide the activities carried on in the original business model such that some of them fell under the list of exceptions defined in Article 5.4 of the OECD Model Tax Convention, i.e., activities of a preparatory or auxiliary nature, and thus did not constitute a PE in the source country.

Conversely, in some instances intentionally constituting a PE was used for tax structuring purposes. One known example consisted in establishing a principal entity hosting a PE in a low-tax jurisdiction while the parent entity was located in a high-tax jurisdiction, with the PE being allocated significant functions, assets and risks, justifying significant profit attribution to such PE.

The basic approach to determining the profits attributable to a PE was and still is as follows:

  • determine the profits under the fiction that the PE is a separate enterprise;
  • apply the arm’s-length principle under the provisions of Article 9 of the OECD Model Tax Convention for the purpose of adjusting the profits of associated enterprises.

Thus, the use of PE was common in business restructurings, notably with a view to obtain tax savings. Because of the strict definition of the concept, national jurisdictions could not effectively limit this use (Conseil d’Etat, June 20, 2003, Case no 224407, Société Interhome and Conseil d’Etat, March 31, 2010, Case no 304715, Zimmer Ltd).

Prevention of Artificial Avoidance of PE Status in International Business Restructurings

This situation has attracted much attention from tax authorities and from the OECD. Tax planning structures have become the bane of policymakers, notably due to media coverage denouncing the fact that such operations deprived public budgets of substantial amounts of revenue. Authorities therefore took action to develop tools in order to address tax avoidance and bring greater consistency to the tax rules applicable to international groups.

The European Commission worked on a Tax Transparency Package where one of the key elements was “to introduce the automatic exchange of information between EU Member States on their tax rulings.”

The OECD and G-20 members initiated the BEPS Action Plan in order to “give countries the tools they need to ensure that profits are taxed where economic activities generating the profits are performed and where value is created, while at the same time give business greater certainty by reducing disputes over the application of international tax rules, and standardizing requirements.”

Among the 15 final reports on BEPS Actions issued in October 2015, two dealt with the issue of avoidance of PE status in tax planning and business restructurings: Action 1 (Addressing the Tax Challenges of the Digital Economy) and Action 7 (Preventing the Artificial Avoidance of Permanent Establishment Status).

The work carried out under BEPS Action 7 led to changes to the definition of PE in the OECD Model Tax Convention to address strategies used to avoid having a taxable presence in a jurisdiction under double tax treaties. In 2017, the definition of the PE agency was then broadened to include situations where the intermediary negotiates the material elements of the contract that will finally be concluded.

In June 2017, the multilateral instrument (MLI) was signed by 67 government ministers with a view to transposing results from the BEPS project into existing double tax treaties without the need for bilateral negotiations on each double tax treaty. As of March 30, 2021, this treaty had been signed by 95 states or territories and ratified by 65 states, and potentially covered nearly 1,700 bilateral tax treaties.

However, since the MLI signing states have the option of choosing whether they wish to fully apply the broadened PE definition or whether they wish to make reservations as to its application, a number of double tax treaty provisions related to the PE definition remained unchanged.

In the meantime, many tax authorities increased the pressure on tax audits and escalated dawn raids. This is notably the case for the French tax authorities, who focused on the recognition of PEs and challenged a number of multinational groups based on the PE concept, such as the “GAFAM” (Google, Apple, Facebook, Amazon, and Microsoft) and other groups with a French subsidiary providing sales and/or marketing services to a foreign affiliate, which were systematically scrutinized and challenged.

In addition, certain countries like France and Italy extended the criminalization of undisclosed PE situations.

In France, the 2018 Tax Fraud Act obliges the French tax authorities to refer to the public prosecutor those cases where they apply the 80% penalty for undisclosed activity, which they systematically do when they find an undisclosed PE. Given this environment, multinational groups facing huge reassessments chose to come to an agreement with the French tax authorities rather than to go to court, sometimes despite a favorable court decision in their case (e.g. Google for about 1 billion euros).

As a result, the pressure to consider PE issues in the case of international restructurings has increased. This is all the more so as in certain countries PE case law is tending to turn less favorable to taxpayers, even in the context of the application of the pre-2017 PE definition.

For instance, in the Conversant case (Conseil d’État, Dec. 11, 2020, no 420174, Conversant International Ltd.) involving the Ireland–France double tax treaty, which still includes the pre-2017 OECD Model Tax Convention main features of the dependent agent PE definition, the French Supreme Administrative Court ruled that a French company can qualify as a dependent agent, and thus as a French PE, of an Irish affiliate, if the French company habitually exercises the authority to conclude contracts in the name of the Irish affiliate; which, according to the Court, is the case where, on an usual basis, and even if it does not formally conclude contracts in the name of the Irish company, the French company decides transactions that the Irish company is merely endorsing and that, so endorsed, engage the Irish company.

The French Conseil d’Etat thus reshaped the boundaries of the dependent agent provision contained in the former OECD Model Tax Convention, by adopting a broader approach to the notion of “authority to conclude contracts in the name of a foreign company” than the one initially taken by the Paris administrative court of appeal, privileging substance over form.

In light of this, many multinational groups have implemented conversions of agents into independent commissionaires or into limited risk distributors in order to try to mitigate their PE risks.

In addition, there is still some leeway as at this stage, as there are countries that have not signed the MLI. Furthermore, some states still have differing views on the PE concept; for instance, two trends have emerged between different states concerning the list of activities that do not constitute a PE (Article 5 (4) of the OECD Model Tax Convention).

Some countries considered that every activity listed should be subject to the condition that they are preparatory or auxiliary, whereas a second set of countries considered that the activities listed were intrinsically preparatory or auxiliary and that they should not be subject to an additional condition. Hence the MLI included two options allowing states to choose between different versions of the text.

In any event, groups could still choose to deploy their key functions, assets and risks in a lower tax jurisdiction where they have a PE, while the parent entity will be located in a high-tax jurisdiction. Going forward, however, the leverage of such structures could be limited by the implementation of Pillars One and Two for the groups that would be in the scope of such measures.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Annabelle Bailleul-Mirabaud is a Partner and Julie Vergnes is a Senior Associate with CMS France.

The authors may be contacted at:;

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