BEPS Action 7 – Artificially Avoiding PE Status

BEPS Action 7  “Preventing the artificial avoidance of permanent establishment status” contains agreed amendments to the definition of “permanent establishment” in Article 5 of the OECD Model Tax Convention, which is widely used as the basis for negotiating tax treaties. These changes address techniques used to inappropriately avoid the existence of a permanent establishment.

The Final Report on BEPS Action 7 included the following:

  • Changes to the rules on deemed permanent establishments (PEs) created by dependent agents, addressing commissionaire arrangements and other undisclosed agent arrangements;
  • Changes to the exceptions from creating a fixed place of business PE for specific activities (such as maintenance of stocks of goods for storage, display, delivery of processing, purchasing or the collection of information) so that these will apply only where the activity in question is preparatory or auxiliary in relation to the business as a whole; and
  • An anti-fragmentation rule that removes exceptions (including those for preparatory or auxiliary activities) in circumstances where activities in a country are carried out by different group companies, where the activities are part of a “cohesive business operation” and not, in the aggregate, preparatory or auxiliary.

Australia’s response BEPS Action 7

Multinational anti-avoidance law (MAAL)

Australia has taken unilateral action on PE issues by enacting the MAAL.  This new legislation is effective for arrangements entered into on or after 1 January 2016.
The legislative source of the MAAL is ITAA 1936 s 177DA in Pt IVA. Section 177DA applies to artificial or contrived arrangements to avoid the attribution of business profits to a taxable permanent establishment in Australia. The measure applies to tax benefits obtained on or after 1 January 2016 if, in connection with a scheme a non-resident entity derives income from the making of a supply of goods or services to Australian customers, with an entity in Australia supporting that supply, and the non-resident avoids the attribution of the income from the supply to a permanent establishment in Australia. Because the measure is incorporated into ITAA 1936 Pt IVA, it generally takes precedence over Australia’s tax treaties.

In the 2016 Federal Budget, the Australian Government proposed to introduce a 40% diverted profits tax (DPT) on the profits of multinational corporations that are artificially diverted from Australia from 1 July 2017. The DPT will target companies that shift profits offshore through arrangements involving related parties:

  • That result in an amount of tax being paid overseas that is less than 80% of the amount of tax that would otherwise have been paid in Australia; and
  • Where it is reasonable to conclude that the arrangement is designed to secure a tax reduction; and
  • That do not have sufficient economic substance.

Diverted Profits Tax (DPT)

The Australian Government has announced a 40 per cent DPT to apply to income years commencing on or after 1 July 2017.  This measure is intended to ensure multinational corporations pay an appropriate amount of tax on profits made in Australia.  The DPT is intended to be based on the insufficient economic substance aspect of the DPT which has applied in the United Kingdom since 1 April 2015.

It is proposed that the DPT would:

  • Apply to income years commencing on or after 1 July 2017, whether or not the relevant transactions were entered into before that date;
  • Apply only to significant global entities (i.e. those groups with global income of $1 billion or more) and an exclusion is proposed for circumstances where the Australian operations are relatively small (Australian group turnover of less than $25 million);
  • Impose a penalty rate of tax (40 per cent) on profits transferred offshore through related party transactions with insufficient economic substance that reduce the tax paid on the profit by 20 per cent or more (i.e. in effect suffer a tax rate of less than 24 per cent);
  • Apply where it is “reasonable to conclude” based on information available to the ATO that the arrangement is designed to secure a tax reduction;
  • Provide the ATO with wider powers to reconstruct an alternative arrangement on which to assess the diverted profits where the related party transaction is assessed to be artificial or contrived;
  • Require upfront payment of any DPT liability which can only be adjusted following a successful review of the initial assessment; and
  • Put the onus on taxpayers to provide relevant and timely information on offshore related party transactions to the ATO to prove why the DPT should not apply.