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HMRC internal manual

International Manual

Non-residents trading in the UK: permanent establishment: domestic and treaty law: permanent establishment definition: BEPS update to Article 5 of the OECD Model Tax Convention in Income and on Capital (‘MTC’)

The OECD/G20 Base Erosion and Profit Shifting project, which considered 15 Action items, concluded with the publication of the Final Reports in October 2015.  The Action 7 Report Preventing the Artificial Avoidance of Permanent Establishment Status recommended changes to  Article 5 of the MTC, which were adopted when the MTC was updated in 2017.  The new and amended provisions are as follows (bold italics indicates new text whereas strikethrough refers to deletion of current text):

Specific activity exemptions from PE

Article 5(4):

‘Notwithstanding the preceding provisions of this Article, the term “permanent establishment” shall be deemed not to include

  1. the use of facilities for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise;
  2. the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery;
  3. the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;
  4. the maintenance of a fixed place of business solely for the purpose of purchasing good or merchandise or of collecting information, for the enterprise;
  5. the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character;
  6. the maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs a) to e), provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character.

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.’

The UK is not adopting this change. Along with most other OECD member states, the UK considers the provisions of subparagraphs a) to d) to be per se exemptions – consistent with the history of the provision, its drafting and the longstanding traditional interpretation, confirmed by the OECD in its 2011 Discussion Draft on Article 5 – and therefore takes the view that they should not be subject to the preparatory or auxiliary test. Taking away the certainty of per se exemptions diminishes the utility of the provision, for both business and tax administrations, of providing clear lines on what activities will not create a taxable presence in a state. It represents a change in the permanent establishment threshold rather than a measure targeted at BEPS. The more targeted anti-fragmentation rule, discussed below, addresses attempts to abuse the exemptions. 

Article 5(4.1):

Paragraph 4 shall not apply to a fixed place of business that is used or maintained by an enterprise if the same enterprise or a closely related enterprise carries on business activities at the same place or at another place in the same Contracting State and

  1. that place or other place constitutes a permanent establishment for the enterprise or the closely related enterprise under the provisions of this Article, or
  2. the overall activity resulting from the combination of the activities carried on by the two enterprises at the same place, or by the same enterprise or closely related enterprises at the two places, is not of a preparatory or auxiliary character,

provided that the business activities carried on by the two enterprises at the same place, or by the same enterprise or closely related enterprises at the two places, constitute complementary functions that are part of a cohesive business operation

Paragraph 4.1 is an entirely new provision and introduces an anti-fragmentation rule, which the UK has adopted, and which will be incorporated into its tax treaties as the Multi-lateral Instrument is implemented.

The purpose of the new rule is to prevent an enterprise or a group of closely related enterprises from fragmenting complementary functions forming part of a cohesive business operation between locations or among enterprises, in order to claim that the resulting multiple smaller operations benefit from one or more of the specific activity exemptions in paragraph 4. In order for the rule to apply:

  • at least one of the places where these activities are exercised must constitute a permanent establishment; or
  • the combination of activities goes beyond what is merely preparatory or auxiliary.

The definition of ‘closely related enterprises’ is found in Article 5(8), see below.

Dependent Agent

Currently the UK has not adopted the changes to Article 5(5) and 5(6). 

Article 5(5):

‘Notwithstanding the provisions of paragraphs 1 and 2* but subject to the provisions of paragraph 6, where a person other than an agent of an independent status to whom paragraph 6 applies is acting *in a Contracting State *on behalf of an enterprise and has, and habitually exercises, in a Contracting State, an authority to conclude contracts,* *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*

  1. in the name of the enterprise, or
  2. 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
  3. for the provision of services by that enterprise,

that enterprise shall be deemed to have a permanent establishment in that State in respect of any activities which that person undertakers for the enterprise, unless the activities of such person are limited to those mentioned in paragraph 4 which, if exercised through a fixed place of business (other than a fixed place of business to which paragraph 4.1 would apply), would not make this fixed place of business a permanent establishment under the provisions of that paragraph.’

Article 5(6):

An enterprise shall not be deemed to have a permanent establishment in a Contracting State merely because it carries on business in that State through a broker, general commission agent or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business.  Paragraph 5 shall not apply where 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.  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.’

Article 5(8):

‘For the purpose of this Article, a person or enterprise is closely related to an enterprise if, based on all the relevant facts and circumstances, one has control of the other or both are under the control of the same persons or enterprises.  In any case, a person or enterprise shall be considered to be closely related to an enterprise if one possesses directly or indirectly more than 50 per cent of the beneficial interest in the other (or, in the case of a company, more than 50 per cent of the aggregate vote and value of the company’s shares or of the beneficial equity interest in the company) or if another person or enterprise possesses directly or indirectly more than 50 per cent of the beneficial interest (or, in the case of a company, more than 50 per cent of the aggregate vote and value of the company’s shares or of the beneficial equity interest in the company) in the person and the enterprise or in the two enterprises.’  

See INTM264800 for details on the Principal Purpose Test.