Tax Treaty Series

ITQ T-

052

August 7, 2020

Question

XCo, resident in X, is a buy-sell distributor of vehicle spare parts. XCo buys the parts from several unrelated suppliers and sells them to unrelated repair shops in X. XCo's annual sales revenue from this activity is $50 million.

XCo also acts as a contract-concluding sales agent for 2 non-resident vehicle spare parts suppliers: YCo (resident in Y and related to XCo) and ZCo (resident in Z and unrelated to XCo). XCo enters into sales contracts, on behalf of YCo and ZCo (respectively), with unrelated repair shops in X. The annual sales revenue from this activity is $5 million (i.e., this is the aggregate of YCo's and ZCo's revenue from sales concluded by XCo). 95% of that sales revenue is on behalf of YCo, with 5% on behalf of ZCo. XCo is paid a sales commission by each of YCo and ZCo.

XCo's agency contracts require it to identify new business opportunities in X for YCo and ZCo. This service, which is not commonly performed by similar agents in X, is not separately remunerated (i.e., it's covered by the sales commissions) – and, for that reason, XCo spends little time in performing this service.

The X/Y treaty and the X/Z treaty are both identical to the 2017 OECD model treaty.

Does YCo have a PE in X? Does ZCo have a PE in X?

Answer

There are 2 conditions which must be satisfied for the Art. 5(6) exception to apply to YCo or ZCo: (a) XCo carries on business in X as an independent agent, and (b) XCo acts for YCo or ZCo in the ordinary course of that business.

YCo: is XCo an independent agent?

Art. 5(6), 2nd sentence: is the "exclusively or almost exclusively" test satisfied?
OECD Comm.: this test should be interpreted as "90% or more".
In applying the test, do you consider all of XCo's activities or only the agency activities?
From the terms of the 2nd sentence, it is clear that you apply the test to the agency activities only
XCo satisfies this test (95%) and thus it fails the "independent agent" condition.
Thus, YCo has a PE in X under Art. 5(5).

ZCo: does XCo act for ZCo in the ordinary course of that business?

The analysis of this condition is made difficult by the 2017 changes to Art. 5(6) and the Commentary. Nevertheless…
XCo performs 2 agency activities for ZCo: (i) concluding sales contracts, and (ii) identifying new business opportunities. Activity (ii) is not commonly performed by similar agents in X.
Arvid Skaar, "Permanent Establishment – Erosion of a Tax Treaty Principle" (2nd edition, 2020) states that this condition refers to the typical activities of agents in the relevant industry. On that basis, activity (ii) is not in the ordinary course of XCo's agency business.
A lack of separate remuneration and little time spent on activity (ii) should, in my view, both be irrelevant.
IMHO: XCo fails the "ordinary course of business" condition.
Thus, ZCo has a PE in X under Art. 5(5).

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