Tax Treaty Series

ITQ T-

032

February 21, 2020

Question

XCo, a company resident in country X, operates a number of large retail stores in X and other countries. XCo establishes, and maintains for a period of 2 years, an office in country Y for the purposes of researching the local market and lobbying the government for law changes which would allow XCo to establish stores in Y.

During that period: (i) the office has 10 employees; (ii) the office manager routinely enters into various types of contracts (on behalf of XCo) such as employment contracts, office lease contract, office cleaning contract, contracts for utilities, contracts for office stationery, and contracts for supply of economic and business information on the local market; and (iii) the office manager and other senior employees frequently entertain senior government officials at football games, restaurants, karaoke bars, etc. That entertainment is illegal in Y, under "anti-corruption" laws.

The X/Y treaty is identical to the 2017 OECD model treaty. Does XCo have a PE in Y under that treaty?

Answer

Art. 5(1):

The tests in Art. 5(1) should be satisfied in regard to the office: (i) specific geographical place; (ii) at the disposal of XCo; (iii) for a sufficiently long period of time; (iv) and through which the business of XCo is wholly or partly carried on.

In regard to test (iv): XCo should be considered as carrying on its business partly through the office, even though the office does not assist in generating any revenue for XCo – see 2017 OECD Comm. para. 7 in regard to "productive character".

The reference to "office" in Art. 5(2) is irrelevant: see 2017 OECD Comm. para 45.

The illegality of the entertainment activities is irrelevant.

Art. 5(4):

The "preparatory or auxiliary character" exception in Art. 5(4)(f) should apply.

The facts are taken from Example 2 in para. 68 of the 2017 OECD Comm, which states that:

"[para.] f) applies to the activities performed through the office (since [paras.] d) and e) would apply to the purchasing, researching and lobbying activities if each of these was the only activity performed at the office) and the overall activity of the office has a preparatory character".

The only material difference in the facts is that our case expressly indicates that the contracts concluded by the office manager include contracts for the supply of services, which are not covered by Art. 5(4)(d). However, that activity should fall within Art. 5(4)(e), and thus there should be no impact on the conclusion.

Art. 5(5):

This should not apply, as all the contracts relate to internal operations: see 2017 OECD Comm. para 97.

Conclusion: No PE.

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