Multinational Enterprises (MNEs) have, over the years, structured their transactions to avoid creating a tax presence or permanent establishment (PE) in operating countries by either taking advantage of double tax treaty safe harbour provisions or ensuring that very limited activities are carried on directly in operating territories.
Under Article 5(4) of the Organisation for Economic Cooperation and Development (OECD) and United Nations (UN) Model Treaties, activities that are auxiliary or preparatory in nature should not create a PE for an enterprise. Recent developments, particularly in the area of the Base Erosion and Proﬁt Shifting (BEPS) and the changing practices of tax authorities, suggest that careful tax planning would be required to ensure that a PE is not created for a non-resident company via activities that were thought to be auxiliary or preparatory in nature.
In this article, we examine the pertinent questions regarding the meaning of what constitutes preparatory or auxiliary activities under Zimbabwean Double Tax Treaties (DTTs) with other countries.
Economic Independence- If either party is able to terminate their contractual relationship, there is no exclusivity; hence, there is economic independence. Entrepreneurial risk is irrelevant; therefore, guarantee of business based on principal is irrelevant.
Eﬀect of a Partnership
Partnership’s PE is deemed to be at every partner’s constant disposal.. Therefore, avoid operating through a partnership. The automatic imputing of a PE via a partnership is based on two theories:
a). Agency Theory- The ﬁrst is that the general active partners are treated as the agents of the passive limited partners. If
e. Quality Inspections- The use of facilities for quality inspections does not constitute a Permanent Establishment.
f. Purchasing Activities- The maintenance of a ﬁxed place of business for the purpose of purchasing raw materials or purchasing goods for resale.
g. Collecting Client Information- The maintenance of a ﬁxed place of business for the purpose of collecting client information.
h. Providing a Communications Link- Maintaining a telephone line between suppliers and customers. In other words, having a local phone number is not enough. Logic would apply this to a virtual oﬃce. What about providing a computer through
The deﬁnition of the term “Permanent Establishment” is fairly uniform among all income tax treaties and will typically be found where there is either a Physical or Imputed PE. In other jurisdictions, failure to ﬁle an income tax return with a treaty disclosure will result in a loss of deductions if it is later determined that there was a PE, so it’s important to determine upfront whether you have a PE.
Physical Permanent Establishment
A Physical PE is a ﬁxed place of business (for example, factory, oﬃce, tent in a marketplace, gas well, mine, etc.) that is at a foreign person’s constant disposal (for example, owned, leased, sharing, or illegally squatting) through which business is carried on (for example, for at least
6 months) and determined under treaty principles without regard to domestic law. A Physical PE can even include a temporary construction site, installation project, or drilling rig for the exploration of natural resources that last more than twelve months.
Business Income Shifting Strategy
A PE can be intentionally created to shift income to another country. For example, under some treaties, “director’s fees” are apportioned based on the area of performance. But if the individual creates a permanent establishment in one country and not in the other, the “director’s fees” would be re-characterised as “business income” that is attributable solely to a permanent establishment in one of the countries. These and other strategies, however, should only be implemented and employed under the guidance and instruction of our ﬁrm. Because, if you do it incorrectly, it could be disastrous for your company.
Coupled with planning under an income tax treaty’s Limitation on Beneﬁts (“LOB”) Article or by focusing on country’s whose income tax treaty with the forum country completely lacks an LOB Article, such as Greece, Hungary, Pakistan, Philippines, Poland, or Romania, it is possible to eﬀectively treaty shop for the best result. However, international tax professionals should take careful note to add a substantial amount of economic substance and non-tax purpose to each step in these arrangements to avoid a counter-attack from tax authorities for lack of economic substance and the step-transaction doctrine, respectively.
Imputed Permanent Establishment
When a non-resident conducts business through a partnership, another’s PE, a dependent agent, or even a not-truly- independent agent, then there are several concerns that the non-resident must consider to avoid having a Permanent Establishment in the forum country imputed to them.
At One’s Disposal
If there is a Permanent Establishment “at the constant disposal” of a non-resident, then it’s attributed to that non-resident. Ask yourself: does the foreign person use the premises as they please? If so, then the foreign person will have that PE imputed to him. If not, continue analysing either in the non-subsidiary or subsidiary context.
Example– Telecoms company- If a corporation engaged in e-commerce through a website that processes orders and also owns or leases the use of servers that host the website, which remain unmoved at a certain location for a suﬃcient period of time so as to become “ﬁxed,” then the place where the server is located is a PE. However, where there is merely a hosting arrangement for a website with an ISP, then the ISP’s computer servers cannot constitute a PE since the ISP would be considered an independent agent acting in the ordinary course of its own business of hosting websites.
Dependent Agency and Subsidiary Analysis Generally, a dependent agent is any person, regardless of whether or not the person is an employee or subsidiary, that is not an independent agent. For a domestic subsidiary’s Permanent Establishment to be attributed to a foreign parent, the foreign parent must either have the Permanent Establishment at its disposal, as mentioned above, or have the discretionary authority to conclude contracts in the name of the principal and must be shown to habitually exercise the said discretion. Mere authority alone is not suﬃcient.
If the subsidiary has the authority to conclude contracts in parent’s name and often uses that power, there will be a ﬁnding of a PE; however, if the subsidiary acts in its own name, there will be no PE. As long as a subsidiary does not allow its PE to be available to the foreign parent (e.g., restricting access to employees of SubCo only and speciﬁcally excluding employees of parent and sister companies) and acts in its own name, the subsidiary’s PE will not be attributed to the foreign parent.
Independent Agency Analysis
Is the agent dependent or independent? The
analysis turns on the discretion of the agent’s authority; whether the principal has interest ownership in the agent, and whether the relationship is permanent or terminable. In other words, is the agent legally and economically independent? An exclusive consignment agent or commissionaire qualiﬁes as an independent agent even if this would constitute taxable presence under domestic l a w of t h e fo r u m c o u n t r y . Tre a t y l a w supersedes domestic law.
Legal Independence- Is the authority to bind discretionary or non-discretionary? If the agent has discretionary authority to conduct business on behalf of the principal, there is a strong showing of legal independence. If the person does business in their own name, there is a presumption of discretion.
If there is no interest ownership in the agent- corporation or an employment arrangement with the agent individual, there can be no de facto comprehensive control.
the limited partners have no binding authority or control, then the active partners are independent agents at best.
b). Interest Theory- The second, and more compelling, theory is that the partnership agreement gives all partners, including passive limited partners, a legal interest
in all assets, including the oﬃces, which creates the permanent establishment for the foreign partner despite the passive nature of the investment.
If the Partnership Agreement (or even an after- the-fact signed and contractually binding Memorandum of Clariﬁcation) creates a new limited proﬁts-only interest that speciﬁcally says that the limited partner has no legal interest in any company assets, there is a very s t r o n g a r g u m e n t t h a t n o P e r m a n e n t Establishment can be imputed to foreign partners.
Digital/Virtual Permanent Establishment Requires companies to pay tax in each Member State where they have a signiﬁcant digital presence.
Arguments against Virtual PE
a). Compliance cost would be high because e-commerce companies may not have a physical presence and will be operating in a diﬀerent jurisdiction without oﬃces and personnel.
b). In respect of digitised products, where shipping documents are absent, there may not be an existing and reliable means of establishing the jurisdiction of the e-commerce transaction.
c). Certainty and Simplicity- if source country taxation is conditional on a threshold, e-commerce companies may be unaware if their economic presence in a certain jurisdiction will exceed the threshold, thereby qualifying for a PE in the jurisdiction.
Exception for Auxiliary Activities
Under the OECD Model Income Tax Treaty, Article
5(4), a Permanent Establishment speciﬁcally does not include the following activities:
a. Marketing Branch- Fixed places of business
solely for the purpose of advertising and marketing company goods or services. Even an independent advertising agency maintained by an enterprise solely engaged in advertising its own company and not others is covered. The use of facilities for the passive marketing, such as a display stand at a trade show or mall, would be included as well. An art gallery that does not take orders would also be protected against Permanent Establishment status.
b. Storage Facility- The use of facilities for the maintenance of a stock of goods or merchandise in a contracting state for storage.
c. Processing/Delivery Facility- The use of facilities for the maintenance of a stock of goods or merchandise in a contracting state for delivery (packing and labelling facility).
d. Warranty Repairs- The use of facilities for warranty-based repairs does not constitute a Permanent Establishment.
which a client can order?
i. Mirror Server- Relaying information through a mirror server for security and eﬃciency purposes.
j. Data Acquisition- Gathering market data for the enterprise and supplying that information.
k. Scientiﬁc Research- Fixed places of business solely for science research.
l. Servicing Patent or Know-How Contract- Fixed places of business solely for servicing patent or know-how contract.
m. Non-Commercial Info-Only Website- If the website merely advertises and does not process orders, not even a server constitutes a PE.
n. Preparatory or Auxiliary Activities- The maintenance of a ﬁxed place of business solely for any other activity of a preparatory or auxiliary character. The 2017 update to the OECD Model Tax Convention provides that a preparatory activity is carried on in contemplation of the essential and signiﬁcant part of the activity of a business, whilst an auxiliary activity is carried on to support, without being part of, the essential and signiﬁcant part of the activity of the business. Similarly, the 2011 UN Model Double Taxation Convention between Developed and Developing Country provides that a ﬁxed place of business whose general purpose is one which is identical to the general purpose of the whole enterprise, cannot be preparatory or auxiliary in nature.
Consequently, the key consideration of what constitutes an auxiliary or preparatory
activity is whether or not the activity forms an, essential and signiﬁcant part of the business as a whole.
Even the recent global developments in international taxation, it is expedient for MNEs operating in Zimbabwe via diﬀerent structures to reassess their activities in order to determine if there would be any exposures or whether it would be necessary to change their business model to reduce any PE exposures.
For more information, please contact our Tax Consultant: Tapiwa Dalu
+263 4 442511-4
This article has been developed as an information resource. It is intended as a guide only and the application of its contents to speciﬁc situations will depend on the particular circumstances involved. While every care has been taken in its preparation, personnel who use this article to assist in evaluating compliance with Insolvency legislations should have suﬃcient training and experience to do so. No person should act