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September 14, 2023

PE Watch | Latest developments and trends, September 2023

BEPS MLI: Tunisia and Papua New Guinea deposit ratification instrument of the MLI

On 24 July 2023 and 31 August 2023, Tunisia and Papua New Guinea deposited their instrument of ratification of the Base Erosion and Profit Shifting (BEPS) Multilateral Instrument (MLI) with the Organisation for Economic Co-operation and Development (OECD), respectively. Tunisia confirmed its preliminary positions of the MLI and chose to apply Article 12 (Agency PE) and Article 13 (Specific Activity Exemptions). Likewise, Papua New Guinea confirmed its preliminary positions of the MLI and chose to apply all of the MLI's Permanent Establishment (PE) provisions.

The MLI will enter into force for Tunisia on 1 November 2023 and for Papua New Guinea on 1 December 2023.

PE case law  

German Court decides on the disposal of a fixed place of business

On 7 June 2023, the German Federal Fiscal Court (BFH) issued a decision (I R 47/20) addressing whether providing services at an airport could establish a PE. The case involved a mechanic residing in the United Kingdom (UK) and Germany who had been providing aircraft maintenance services at a German airport from 2008 to 2014. These services were performed as a subcontractor for a British entity (the primary contractor) that had entered into a service contract with the German customer.

On the airport premises, the mechanic had access to facilities such as hangars, changing rooms, administration spaces and common areas. The primary contractor rented rooms from the German customer to which the mechanic had access. Additionally, a locker labeled with his name and the primary contractor's name was at his disposal. Upon entry to the premises, the mechanic underwent security checks and held a security pass for the airport. While performing his services, he brought his tools with him and took them with him whenever he departed the airport premises.

The German Tax Authorities argued that the mechanic's substantial presence in Germany gave rise to the existence of a PE. The mechanic contested this assessment in a lower tax court, which ruled in his favor. The lower tax court emphasized that the mechanic's tools and equipment were not permanently stored at the premises but rather transported as needed, thus not meeting the criteria for establishing a PE.

The German Tax Authorities appealed this decision, leading to the BFH's verdict overturning the lower tax court's ruling. According to the BFH, the mechanic did have a PE in Germany within the context of the UK-Germany tax treaty during the assessment years. The BFH considered the mechanic to have had access to and power of disposal of the airport premises, secured under the freelancer agreement with the primary contractor and the services agreement between the primary contractor and the German entity, allowing subcontractors to use these facilities. Another factor highlighted by the BFH was the locker's suitability for storing tools, equipment, and personal and work clothing, which indicated personal-restricted use structures at the premises related to the services performed. In the view of the BFH, the fact that the mechanic did not store his tools and equipment in the locker was irrelevant.

Indian Court's decision on profit attribution for a transportation and logistics company

On 31 July 2023, the Mumbai Income Tax Appellate Tribunal (ITAT) published decision No.2463/Mum/2022 and 2464/Mum/2022, addressing the attribution of profits to a PE in India. In this case, a Dutch entity provided transportation and logistics services to two affiliated entities in India. These services were carried out from an Indian airport to its ultimate destination outside of India, and vice-versa. The two affiliated entities handled transportation and delivery between Indian airports and their respective destinations in India. Further, the Dutch entity did not have any of its operations, employees or assets in India.

The tax authorities asserted that the Dutch entity had a business connection in India and also constituted an Agency PE. In response, the Dutch entity contested the attribution of profits to the Agency PE but did not challenge the existence of a PE.

According to the ITAT, the entire economic activity was carried out by the two affiliated entities in India. Moreover, the ITAT determined the transactions between the Dutch entities and the affiliated entities in India to be at arm's length, based on the transfer pricing documentation after taking into account all functions, assets and risks of the Dutch entity in India. The ITAT's ruling relied on a Supreme Court decision, which held that no additional profits could be attributed, even if a PE existed in India. This is the case when transactions between a foreign enterprise and an Indian entity that is a PE are conducted at arm's-length prices. As a result, no further profit attribution can be made.

Indian Court rules on attribution of profits to a PE on offshore activities

On 19 July 2023, the New Delhi Income Tax Appellate Tribunal (ITAT) published decision 2259/2022 and 2260/2022, regarding the attribution of profits to a PE in India. The case involved a Japanese entity with multiple project offices and a branch office, all recognized as PEs. These offices generated income from various Indian customers in the power and railway sector. The income arose from onshore procurement and supply of goods and services in India and offshore procurement and supply of goods.

The PE in India considered only onshore procurement and supply of goods as part of the income to be taxable in India, but the Indian tax authorities disagreed, also attributing profits to offshore procurement and supply of goods.

The ITAT noted that the PE in India had no involvement in the offshore procurement and supply of goods, because the equipment provided to customers in India was manufactured in Japan and directly delivered to them. The project offices in India only took care of the administrative aspects of customs duty compliance in India, including payment of customs duty, which was charged back to the Japanese entity. These activities performed by the PE in India were covered under the scope of work for the onshore procurement and supply of goods. As a result, the ITAT determined that income from offshore activities cannot be attributable to the PE in India.

Spanish Supreme Court clarifies proportional attribution of profits to a PE

On 17 July 2023, the Spanish Supreme Court issued decision STS 3310/2023 - ECLI:ES:TS:2023:3310, addressing the attribution of profits to a PE of a Spanish entity. When calculating corporate income tax, the head office deducted general management and administrative expenses associated with the PE. However, the Spanish tax authorities disagreed, asserting that these expenses should also be proportionately attributed to the PE. This attribution would alter the tax bases of both the PE and the head office, as Spanish law exempts PE-generated income.

The tax authorities calculated PE expenses by comparing the PE's net investment to total net tangible assets within the consolidated financial group statements.

According to the Spanish Supreme Court, the central issue does not stem from applying a proportionality criterion to identify general management and administrative expenses relevant to the PE. Instead, it arises from the prior selection of these expenses. Only expenses reasonably linked to the PE should be proportionally distributed because an inaccurate initial selection undermines the validity of the proportionality criterion. The tax authorities' calculation incorporated some general management and administrative expenses from Spain that were unrelated to the PE's activities.

To support its decision, the Spanish Supreme Court relies on the domestic PE exemption provisions included the Spanish Corporate Income Tax Law, as the OECD commentary to the Model Tax Treaty is not legally binding and cannot be claimed before the Court.

As a result, the Spanish Supreme Court's decision asserts that tax authorities can proportionately attribute general management and administrative expenses, provided these expenses are incurred for the purposes of the PE.

Swiss Supreme Court confirms absence of a PE in China

Recently, the Swiss Federal Supreme Court published decision 9C_647/2022, in which it examined the cost deductions incurred by a Swiss entity related to a potential PE in China. The case revolved around a Swiss entity engaged in purchasing products from manufacturers based in Asia. Operational activities were carried out by a few employees in an office rented in China.

The Swiss entity sought to deduct its business-related expenses in China, claiming the presence of a PE in that jurisdiction. But, the Swiss cantonal tax authorities contested this claim and adjusted the business-related expenses to the taxable profit of the Swiss entity. The Swiss entity filed an appeal, advocating for the application of a substance-over-form approach.

The Cantonal Court determined that the fixed place of business of the China office was attributable to the direct shareholder of the Swiss entity on the basis that: (i) the rental agreement was under the name of the Swiss entity's parent company; (ii) the persons employed in the China office were not employed by the Swiss entity; and (iii) the local office manager in China reported directly to the chief financial officer of the Swiss entities' parent company. In addition, the Cantonal Court concluded that assuming costs in connection with the PE did not establish power of disposal over the fixed place of business.

Subsequently, the Swiss Federal Supreme Court concurred with the decision of the Cantonal Court and pointed out that neither Swiss tax law nor double tax treaty law indicates a PE under the given facts. Accordingly, the business-related expenses were considered as a deemed dividend and the denial of cost deduction justified.


For additional information with respect to this Alert, please contact the following:

Ernst & Young Belastingadviseurs LLP (Netherlands)

Ernst & Young Solutions LLP (Singapore)

Ernst & Young LLP (United States)

Published by NTD’s Tax Technical Knowledge Services group; Carolyn Wright, legal editor


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