Tax Treaty Series

ITQ T-

046

June 19, 2020

Question

XCo, a company resident in X, carries on a construction business.

It has contracted to undertake a construction project in Y. XCo has estimated that the construction project would take 4 months to complete.

50 of XCo’s employees (all of whom are resident in X) travelled to Y, in February 2020, to undertake the project.

The emergence of COVID-19 caused the Y government to order, on 15 March 2020, all construction projects to cease, with immediate effect. On the same date, without notice, both X and Y prohibited all international travel. Thus, with effect from that date, the project was halted, and XCo’s employees were stranded in Y.

XCo currently expects that work on the construction project will re-commence on 1 July 2020. It estimates that the project will be completed on 30 September 2020.

The X/Y treaty is identical to the 2017 UN model treaty. Y’s year-end for income tax purposes is 30 June.

Q1: Assuming XCo derives a profit from the project, does the treaty permit Y to tax all or part of that profit?

Q2: If XCo incurs an overall loss on the project, does the treaty permit Y to tax a profit in regard to the project?

Answer

Q1:

PE existence:

Key issue: is the 6 months test in Art. 5(3)(a) satisfied?
- 2017 UN Comm. quotes, with approval, 2014 OECD Comm. which states that "temporary interruptions" should be included in determining time.
- OECD Secretariat Analysis of Treaties and Covid-19 (3 April 2020) states that COVID-19 is a temporary interruption for this purpose.
I agree – the 6 months test should be satisfied (i.e., February – September 2020).That raises the issue of the relationship between Art. 5(1) and Art. 5(3)(a): is Art. 5(3)(a) a separate form of PE, or is it merely a qualification on Art. 5(1) (i.e., to find a PE, the other conditions in Art. 5(1) must be satisfied)? Note that the 2017 UN Comm. refers to this issue, but does not determine it.
- This issue could be relevant in this case, as the project site was possibly not "at the disposal" of XCo from 16 March to 30 June – Y laws might have made entry to the site illegal during that period.
- Nevertheless, IMHO: Art. 5(3)(a) is a separate form of PE, due to the drafting differences between that provision and Art. 5(3) of the OECD model.
The fact that the project straddles the Y year-end is irrelevant.
Thus, XCo has a PE.

Profit attribution:

The profits attributable to the PE under Art. 7(1) will be based on the assumption that the PE is a separate and independent enterprise: Art. 7(2).
Based on the limited facts, it appears that the PE should be characterised as a service provider to the head office (with its remuneration probably determined on a cost plus basis), and the head office should be characterised as an entrepreneur taking the substantive risks. The risk of a “black swan” event like COVID-19 (and its financial consequences) should be assigned to the head office. Thus, a profit would likely be attributed to the PE.

Q2:

The profit attributable to the PE should be determined in the same way, regardless of whether the project has an overall profit or loss (see Q1 above).

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