The entire country is now talking about an acronym with three letters – GST... the Goods and Services Tax, followed by three ‘Ones' to describe it – One Nation, One Market, One Tax. Another significant development took place in June this year, which impacts not only India, but all tax jurisdictions, and coincidentally, it is also an acronym with three letters – Multilateral Instrument) followed by three ‘ones' to describe it – One Negotiation, One Signature, One Ratification.
This article provides an overview of the MLI and discusses the impact of the MLI on the concept of Dependent Agent Permanent Establishment (DAPE).
The Base Erosion and Profit Shifting (BEPS) project of the Organisation for Economic Co-operation and Development OECD/G20 developed 15 action items to tackle BEPS. While some action items required changes in the transfer pricing guidelines, certain action items required changes in the existing tax treaties. Currently, the tax treaty network consists of more than 3,000 treaties globally. Negotiating each of them bilaterally would have taken decades. Therefore a multilateral instrument was developed to ensure swift, effective and consistent implementation of BEPS changes in the existing bilateral treaties.
The MLI consists of two categories of provisions – minimum standards and non-minimum standards. Minimum standards apply to all the signatories of the MLI. For example, principle purpose test is a minimum standard.
When it comes to the non-minimum standards, countries have the flexibility to opt out of a provision either entirely or partly. Provisions relating to a permanent establishment (PE) are non-minimum standards. Where a country uses a reservation to opt out of a provision, that provision will not apply to the reserving country and all other treaty partners that are signatories to the MLI. Similarly, a provision will modify the existing treaty only if both the treaty partners have opted for the same provision or chosen the same option in the MLI.
70 jurisdictions have signed the MLI so far. These countries have notified the provisional list of notifications and reservations on the MLI to the OECD. The timing of entry into effect of the modifications is linked to the completion of the ratification procedures in the respective jurisdictions. The OECD expects the first modifications to covered treaties to become effective during the course of 2018.
India's Position
India has a treaty network with 93 countries. Out of the 93 treaty countries, while India has notified all treaty countries in the MLI, only 49 countries have notified India in the list of treaties for applicability of the MLI. Therefore, the MLI will apply to these 49 treaties only.
Certain countries have signed the MLI but have not listed India as a country to be covered by its MLI provision.
Some of these countries are Germany, Mauritius, China, Isle of Man, etc. Therefore, the existing treaties will apply with these countries. Major treaty countries that have not signed the MLI are the United States, Malaysia, the United Arab Emirates, etc. Treasury officials from the U.S. stated that U.S. treaties have no room for treaty abuse.
Dependent Agent Permanent Establishment
Simply put, a DAPE is created when an enterprise resident of a contracting state becomes taxable in another host country on its business profit, if it is represented by an agent in the host country, and the agent has and habitually exercises an authority to conclude the contract.
This DAPE threshold was widened by the BEPS project to include an agent habitually playing the principal role leading to the conclusion of contracts that are routinely concluded without material modification. The objective is to tackle the situation where a contract is substantially negotiated in a country but is not formally concluded there as it is finalized or approved outside. The revised OECD commentary is of limited assistance in interpreting the terms ‘principle role' and ‘material modification'. The OECD commentary states that ‘principle role' will include ‘convincing' a customer to enter into a contract.
India has opted for the revised PE threshold of habitually playing the principal role leading to the conclusion of contracts.
Some of India's key treaty partners such as France, Japan, Netherlands, etc. have also opted for the revised threshold. Therefore, after the ratification of the MLI by these countries, the revised PE definition will apply.
However, some of India's significant treaty partners have not opted for the revised threshold. For example, Ireland has not opted for the revised threshold due to the continuing significant uncertainty as to how the test would be applied in practice. Other countries which have not opted for the revised threshold include the United Kingdom, Ireland, Italy, Singapore, Australia, etc. The revised DAPE threshold will not impact these treaties.
Even though the U.K. has not adopted the revised DAPE threshold, it has already enacted the Diverted Profit Tax (DPT) to tax multinational enterprises who sell to U.K. customers by avoiding a U.K. PE and where the activities connected to those sales are carried out by a U.K. related entity. Similarly, Australia has also introduced its own version of the DPT – Multinational Anti Avoidance Law. France also followed suit and proposed an anti-abuse measure similar to the DPT. However, the measure was struck down by the French Constitutional Court.
Closer home, even in the absence of the revised threshold, the tax authorities have always taken a very aggressive position on the DAPE threshold. The existing OECD commentary states that ‘authority to negotiating all elements and details' of the contract will be considered to be an authority to conclude a contract. However, India has made a reservation in the OECD commentary to suggest that mere attending or participating in negotiations, can in certain circumstances, be sufficient to create a DAPE.
India has also opined that negotiating essential elements of the contract and not necessarily all the elements and details of the contract can be considered to be exercising authority to conclude the contract.
In addition to the above, many treaties negotiated by India have a ‘habitually secures order' test as well. Therefore, after the ratification of the MLI provisions, from a DAPE perspective, the following three alternative languages will remain in India's treaties:
- Habitually concludes contracts test (e.g. treaties with South Africa, the U.A.E., etc.)
- Habitually secures orders test (e.g. the U.S., Italy, Germany, etc.)
- Principle role test -- new threshold as per the MLI (e.g. France, Netherlands, etc.)
India has always maintained that BEPS project has endorsed India's long-standing position on various issues. Considering India's aggressive stance on the DAPE provisions, it will not be surprising if India starts interpreting the existing treaties aggressively pending ratification of the MLI provisions. Only time will tell how the revised threshold is interpreted by the jurisdictions around the world.
Companies should start reviewing their existing structures to see if they will trip the DAPE threshold based on the modified treaty language.
DAPE Profit Attribution
A discussion on DAPE is incomplete without talking about profit attribution. The existing guidance issued by the OECD in 2010 on attribution has proved to be of limited use for industrial companies. On June 22, the OECD released a discussion draft providing additional guidance on the attribution of profits to PE. The draft guidance proposes a distributor margin approach for attributing profits to a DAPE. This is a welcome sign. However, the tax authorities in India have a preference for using formulary apportionment in most cases. Jurisprudence is now evolving in favour of using transfer pricing based approach for attribution.
Some landmark cases are pending before the Indian courts on the issue of DAPE and profit attribution. This is an area on which the final word has not been spoken yet and therefore, remains a key area of uncertainty and litigation for taxpayers.
Conclusion
MLI is a significant change in the field of international taxation and treaty law. Instead of waiting for 2018, taxpayers should start reviewing their structures from a PE perspective now. Taxpayers will need to keep in mind the existing treaties, the MLI, country positions, Indian and global jurisprudence to review the structures. DAPE is and has always been a contentious area in tax. While the definition of DAPE has changed as a result of BEPS project, what remains permanent is the uncertainty and litigation around it and with the introduction of the revised DAPE threshold, it is not likely to go away soon.
Jitendra Jain is Executive Director – Transfer Pricing at PricewaterhouseCoopers.
The views expressed here are those of the author's and do not necessarily represent the views of BloombergQuint or its editorial team.
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