Tax Treaty Series

ITQ T-

048

July 3, 2020

Question

XCo, a company resident in X, is the parent company of a global group.

One of its subsidiaries is YCo, a company resident in Y. YCo carries on a manufacturing business in Y.

XCo opens a liaison office (“L.O.”) in Y. The L.O. has its own leased office, and has one employee (Ms A, a national of X, but resident in Y).

Ms A’s role is to:

Identify possible business opportunities for XCo in Y and nearby countries, and communicate these to XCo
Promote technical cooperation between XCo and its subsidiaries in Y and nearby countries, and also between such subsidiaries themselves
Act as communication channel between XCo and its subsidiaries in Y and nearby countries

The X/Y treaty is identical to the 2017 OECD model treaty.

Does the treaty permit Y to levy income tax on XCo?

Answer

Existence of PE:

1. Art. 5(1) satisfied

2. Art. 5(4):

i. Subject to one qualification, Ms A’s role probably falls within para. (e) or para. (f), on the basis that the activities are of a preparatory or auxiliary character in regard to XCo.

ii. The qualification concerns promoting technical cooperation between XCo's subsidiaries themselves. That aspect of her role is arguably not preparatory or auxiliary from the perspective of XCo, but instead it is a service performed by XCo for those subsidiaries. If that is the case, then Art. 5(4) is not satisfied, due to the "solely" requirement in para. (e) and para. (f).

iii. Even if Art. 5(4) is satisfied, Art. 5(4.1) must be considered. YCo, a closely related enterprise, has a PE in Y (its manufacturing premises). The issue is: are the business activities carried on by Ms A at the L.O. and YCo's activities at its manufacturing premises "complementary functions that are part of a cohesive business operation"?

iv. Note that part of Ms A's role involves promoting technical cooperation between XCo and YCo – would that connection cause Art. 5(4.1) to be satisfied? That's a difficult question to answer. However, it seems from the drafting that, to trigger Art. 5(4.1), all of the activities at the 2 places must satisfy the test, "complementary functions that are part of a cohesive business operation" – not just some (as is the case here). On balance, I think that Art. 5(4.1) is not triggered.

v. IMHO: Art. 5(4) is not satisfied, due to the above-mentioned service element in Ms A's role.

3. Thus, IMHO: the L.O. is a PE.

Profits attributable to PE:

1. Art. 7(1) would allow Y to levy income tax on the profits attributable to the L.O., determined on the assumption that the L.O. is an independent enterprise and dealing at arm's length with the other parts of XCo (Art. 7(2)). Note that the profits attributable to the L.O. would reflect all of the L.O.'s activities, not merely the above-mentioned service element in Ms A's role.

2. In determining the profits attributable to the L.O., the services performed by the L.O. for XCo's subsidiaries (even those subsidiaries which are not resident in Y), would be deemed to be for arm's length consideration: OECD Comm. on Art. 7(2) – unless (generally) they are duplicate services (2017 OECD TPG).

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