Tax Treaty Series

ITQ T-

034

March 6, 2020

Question

ACo, a company resident in country A, manufactures consumer goods. It owns a warehouse in country B. The warehouse is operated by country B employees of ACo.

BCo is a company resident in B and it is a 100% subsidiary of ACo. BCo is the exclusive distributor of ACo's goods in B. BCo takes relatively little risk; it does not take any market or physical inventory risk. This is achieved by the use of a "flash title" model: the goods are sold by ACo to BCo only when, and to the extent, that BCo has contracts to sell the goods to its customers; and the price is set by reference to the price charged by BCo to its customers, giving BCo a guaranteed gross margin.

Thus:

Step 1: ACo physically moves the goods from A to the warehouse in B. Importation is subject to customs duty and VAT. ACo is the importer of record.
Step 2 (days or weeks after step 1): ACo sells some goods to BCo. This sale contract is concluded between BCo and ACo's employees in A. ACo's employees at the B warehouse play no role with regard to the conclusion of the contract. Under the contract, title in the goods passes to BCo when possession of the goods is given to BCo or its agent.
Step 3 (at same time as step 2): BCo enters into sale contracts with customers. ACo's head office gives instructions to ACo's warehouse employees to release the required amount and type of goods to BCo's third party logistics company (XCo). Acting upon BCo's instructions, XCo picks up the goods at ACo's warehouse (title in the goods passes to BCo at this point), and delivers them to the customers.

The A/B treaty is identical to the 2017 OECD model treaty.

Does ACo have a PE in B under the treaty? If so, how would you determine the profits attributable to the PE?

Answer

Warehouse:

Art. 5(1) tests satisfied
Art. 5(4):
Art. 5(4.1) satisfied: business activities carried on at ACo's warehouse and BCo's business premises "constitute complementary functions that are part of a cohesive business operation": see Example B in OECD Comm., para. 81
Thus, Art. 5(4) not satisfied
Thus, Art. 5(1) PE

BCo's premises:

No indication that ACo's employees visit BCo's premises

VAT registration:

ACo is probably registered for VAT purposes in B. However, this has no relevance to ACo's PE status: see OECD Comm., para. 5

Art. 5(5):

Not satisfied in regard to "flash title" model: see OECD Comm., para. 96

Art. 7(1):

The profits attributable to the warehouse PE are the profits which an independent warehouse company would derive from performing the warehouse activities: see 2018 OECD guidance

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