OECD New "Service PE" proviso

Did you ever noticed that some source countries are slightly reluctant to adopt the principle of exclusive residence taxation of services performed on their territory, which are not attributable to a Permanent Establishment (PE) in that source country? Believe me, there are enough countries out there supporting service PE clauses...perhaps in Asia....

The OECD did notice and therefore decided to propose (just in case) some clarification into the Commentary on Article 5, reflecting the conclusion that the current provisions of the OECD Model Tax are appropriate to deal with services (i.e. the right result for services is residence-based taxation). Just for the sake of clarity and completeness, the OECD also includes an alternative provision to be added to Art. 5 for those "rogue countries" that for one reason or another which to preserve source taxation rights on profits from certain services.

Surprised?

You shouldn't be. Just remember that the OECD is no longer an exclusive club of rich (ups..high developed) countries supporting residence-based taxation. In recent years, just as the world economy, the OECD has become more flat! (read the book the World is Flat and you will understand why!). The inclusion of a (alternative) provision on the taxation at source of certain services (even if hidden in the deepness of the Commentaries) is a sign that in an increasingly service-based economy, new challenges lie ahead on international taxation. Now countries can decide to use it or not!

The discussion draft entitled “The Tax Treaty Treatment of Services” includes new paragraphs 42.11 to 42.45 to the Commentary on Art. 5 of the OECD Model. The new paragraphs address the appropriateness of the current provisions of the OECD Model to deal with the tax treatment of services, views (and policy reasons) of States that do not agree with the principle of exclusive residence taxation of services and finally a alternative paragraph for Art. 5 of the OECD Model that secures additional source taxation rights, in certain circumstances, with respect to services performed within the territory of the source State.

For the States that wish to secure additional taxing rights on services, the OECD suggest the inclusion of a new paragraph which operates as an extension of the permanent establishment definition in conformity with the following principles:
- taxation of services should not extend to services performed outside the territory of the source State;
- taxation of services should apply only to the profits from these services rather than to the gross amount of the service fees; and
- taxation of services should involve a minimum level of presence in the source State, requiring for example a certain days of presence and a link between the revenues and the services or type of business activities performed.

The alternative OECD service PE clause included in paragraph 42.23 of the discussion draft, reads as follows:

"Notwithstanding the provisions of paragraphs 1, 2 and 3, where an enterprise of a Contracting State performs services in the other Contracting State
a) through an individual who is present in that other State during a period or periods exceeding in the aggregate 183 days in any twelve month period, and more than 50 per cent of the gross revenues attributable to active business activities of the enterprise during this period or periods are derived from the services performed in that other State through that individual, or
b) during a period or periods exceeding in the aggregate 183 days in any twelve month period, and these services are performed for the same project or for connected projects through one or more individuals who are performing such services in that other State or are present in that other State for the purpose of performing such services, the activities carried on in that other State in performing these services shall be deemed to be carried on through a permanent establishment that the enterprise has in that other State, unless these services are limited to those mentioned in paragraph 4 which, if performed through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph."

If the conditions of such provision are fulfilled, the service activities are therefore deemed to be carried on through a PE and the profits derived from such activities taxable in the source State pursuant to Art. 7 (business profits).

The proposed provision is different than the UN Model service PE provisio. When comparing the existing Art. 5 of the UN Model (2001) with Art. 5 of the OECD Model (2005), it can be said that under the UN Model there are more situations leading to a permanent establishment than under the OECD Model. This isthe case for example under Para. 3 (b) of Art. 5 of the UN Model, “the term "permanent establishment" also encompasses: (…) (b) the furnishing of services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose, but only if activities of that nature continue (for the same or a connected project) within a Contracting State for a period or periods aggregating more than six months within any twelve-month period.”.

A simple search in IBFD database retrived almost 500 real treaties with this language. This means that the OECD inclusion in the Commentary of a service PE perhaps is intended to brign the Model closer to developing nations and at the same time clarify some basic principles regarding cross-border services.

Finally, the discussion draft takes the opportunity to include additional language to paragraph 10 of the Commentary on Art. 17, allowing taxpayers to be taxed on their net income (instead of gross profits) as if they were residents.

The Tax Treaty Treatment of Services: OECD Public discussion draft on proposed Commentary changes, released on 8 December 2006