Tax Treaty Series

ITQ T-

056

September 4, 2020

Question

ACo, a company resident in A, sells “Group X” electronic products.

BCo, a related company resident in B, is a buy/sell distributor of the “Group X” electronic products, which it purchases from ACo on a “consignment” / “flash title” basis.

BCo has several retail stores in B, at which it displays the full range of “Group X” electronic products. At those stores, BCo’s employees spend most of their time demonstrating the products to potential customers. Customers who decide to purchase “Group X” electronic products, can do so in either of 2 ways: (i) purchase from BCo at a retail store in B; or (ii) purchase from ACo via its website (the products would then be delivered to the customers, directly from offshore, by a logistics company). The price for (ii) is lower than the price for (i).

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

Does the treaty permit B to levy income tax on ACo’s profits from the sale of “Group X” electronic products?

Answer

Art. 5(4)

ACo owns the products while they are on consignment with BCo at BCo’s retail stores. It is possible that the exceptions in Art. 5(4)(a)&(b) are not satisfied, on the basis that the activity (i.e., BCo’s maintenance and display of the products) is not of a preparatory or auxiliary character, from ACo’s perspective. It is also possible that Art. 5(4.1) prevents Art. 5(4) from being satisfied, on the basis that each of BCo’s retail stores is a PE of BCo and the business activities carried on by ACo and BCo at those stores “constitute complementary functions that are part of a cohesive business operation”.

However, even if Art. 5(4) is not satisfied, ACo will not have a fixed place of business PE in B unless the tests in Art. 5(1) are satisfied (see below).

Art. 5(1)

The key issue is whether the “at the disposal” test is satisfied.

It is possible that ACo, pursuant to its distribution contract with BCo, is permitted to (and does) dictate the layout and style of the retail stores, and the day-to-day activities of BCo’s employees, to such an extent that ACo is seen to exercise practical control over the stores and/or the employees – in which case, BCo’s retail stores could be considered to be “at the disposal” of ACo.

Art. 5(5)(a)

BCo’s employees do not conclude contracts “in the name of” ACo. Also, the fact that BCo is a buy/sell distributor in regard to ACo, and takes “flash title” to the products sold via the stores, should not cause Art. 5(5)(a) to be satisfied: para. 96, OECD Comm.

However, the fact that the employees demonstrate the products to potential customers, some of whom purchase the products from ACo online, might cause the “habitually plays the principal role…” limb in Art. 5(5)(a) to be satisfied: para. 88, OECD Comm.

Conclusions on PE

ACo might have a PE in B under Art. 5(1) or Art. 5(5)(a) or both.

Art. 7(1)

If ACo has an Art. 5(1) PE, the profits attributable to the PE would cover the store sales (from ACo to BCo), but would possibly not cover the online sales from ACo to B csutomers. However, the “modified force of attraction” (MFOA) rule in Art. 7(1) would probably “catch” the profits attributable to the online sales.

If ACo has an Art. 5(5)(a) PE, the profits attributable to the PE would cover the online sales, but would possibly not cover the store sales. However, the MFOA rule would probably “catch” the profits attributable to the store sales.

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