Tax Treaty Series

ITQ T-

107

October 29, 2021

Question

XCo, a company resident in X, is in the business of generating electricity through wind turbines.

As part of its business, it purchased land in Y, on which wind turbines and related assets ("wind farm") were constructed.

All of the decision-making in regard to the establishment of the wind farm was made by XCo's employees in X. In fact, XCo has no employees who are based in Y, and XCo’s employees do not regularly visit Y.

To construct the wind farm, XCo engaged YCo 1, an unrelated company resident in Y, to construct the wind farm as a service for it. The components for the construction were purchased by XCo and physically transferred to YCo 1. Ongoing maintenance of the wind farm is also performed by YCo 1, as a service for XCo. Legal and administrative arrangements for the sale of the electricity into the Y electricity grid, are performed by YCo 2, another unrelated company resident in Y, as a service for XCo – however, YCo 2 does not conclude contracts on behalf of XCo.

The X/Y treaty is identical to the 2014 OECD model treaty.

Questions:

(1) Does XCo have a PE in Y?

(2) If XCo does have a PE in Y: in determining the profits attributable to the PE under Art. 7, what functions, assets and risks would be allocated to the PE, on the assumption that it is a "separate and independent enterprise"?

Answer

Q1:

The wind farm would constitute a "fixed place of business" PE for XCo under Art. 5(1).

Q2:

The allocation of XCo's functions, assets and risks to the PE should be done in accordance with the OECD Comm. on Art. 7 and the OECD's 2010 report on attribution of profits to PEs.

The question indicates that all of the significant people functions (SPFs) are performed by XCo's employees in X, that XCo has no employees who are based in Y, and XCo's employees do not regularly visit Y.

What impact does that have on the determination of the functions, assets and risks allocated to the PE?

(i) Functions:

The only function which would be allocated to the PE would be the physical performance of the wind farm. All of the management functions (including the appointment and monitoring of YCo 1 and YCo 2) are performed by the head office employees.

(ii) Risks:

All of the risks which relate to the wind farm (e.g., market risk, currency risk, credit risk, physical risk) are managed by employees at the head office, and thus those risks would be allocated to the head office.

(iii) Assets:

If the SPF approach were strictly followed in regard to the ownership of tangible assets, then the ownership of the wind farm (including the land) would be allocated to the head office. However, the OECD's 2010 report advocates a "pragmatic solution": ownership of tangible assets (including land) would be attributed based on use (see para. 75). [Note the contradictory statement in regard to the ownership of a computer server: para. 66.]

Thus, despite the absence of SPFs, the PE should be allocated the ownership of the wind farm and land. In regard to the remainder of "step one" (i.e., hypothesising the PE as a separate and independent enterprise):

(iv) Contractual rights and obligations:

All of XCo's contractual rights and obligations in regard to the wind farm (in particular, the contracts with the Y electricity grid) would be allocated to the head office.

(v) Capital:

As the PE would be allocated ownership of the wind farm and land, its notional capital base (equity and interest-bearing debt) should be sufficient to fund those assets.

(vi) Notional dealings:

Based on the above, the notional dealings between the head office and the PE should be: (a) head office would own equity and interest-bearing debt issued by the PE; and (b) the PE should operate the wind farm as a service for the head office.

ITQ Disclaimer

This International Tax Quiz (ITQ) contains general information only, and none of International Insights Pte Ltd, its employees or directors is, by means of this ITQ, rendering professional advice or services. You use the content of this ITQ strictly at your own risk. You should not rely on all or any part of the content of this ITQ in making decisions to take action (including inaction) in regard to tax or other matters. Before making any decision or taking any action (including inaction) that may affect your tax position, your finances or your business, you should consult a qualified professional advisor. None of International Insights Pte Ltd, its employees or directors shall be responsible for any loss whatsoever sustained by any person who relies on the content of this ITQ.