BEPS Action 7: Preventing the Artificial Avoidance of Permanent Establishment Status

By Jim Alajbegu, CPA; Shaun Gillum, J.D., LL.M.; Chip Niculae, J.D.; and Erik Rudman, J.D., LL.M., New York City

Editor: Mark Heroux, J.D.

The Organisation for Economic Co-operation and Development's (OECD's) base erosion and profit-shifting (BEPS) project, launched in 2013 in conjunction with the Group of Twenty (G-20), an international forum of the governments and central bank governors from 20 major economies, is intended to combat aggressive tax planning strategies that have the effect of shifting profits from high-tax jurisdictions to low-tax jurisdictions. The BEPS project itself has been divided into 15 proposals, or "actions." Without a doubt, one of the most far-reaching of these actions in terms of the number of companies that would be affected (regardless of size) is Action 7, Preventing the Artificial Avoidance of Permanent Establishment Status.

The stated purpose of Action 7 is to attack certain "artificial" arrangements nonresident enterprises have entered into to avoid having a taxable presence, or permanent establishment (PE), in a country, such that the taxable profits from operations in that country will be subject to tax only in the home country of the nonresident (presumably at a lower rate) under the "Business Profits" article of the relevant income tax treaty. In proposing changes to the definition of a PE in the OECD Model Tax Treaty, Action 7 focuses on perceived avoidance of PE status using agency or similar (e.g., sales commissionaire) arrangements or relying on specific exemptions from the definition of a PE, particularly those relating to "preparatory and auxiliary" activities.

Under the current OECD model language, two circumstances in which a PE will be established in a country are (1) where a nonresident company has a fixed place of business in that country; or (2) where the nonresident company has a dependent agent concluding contracts on its behalf in that country. Profits attributable to a PE are generally taxable in the country in which that PE is located.

Under the current OECD model, an agent in a country acting on behalf of an enterprise will create a PE in that country if the agent "habitually exercises authority to conclude contracts in the name of the enterprise," unless the agent is an independent agent acting in the ordinary course of its business (the independent agent carve-out). An agent is regarded as independent where it is legally and economically independent from its principal.

The OECD proposes to change both parts of this test. The overall purpose of these proposed changes is to ensure that where the activities an intermediary exercises in a given country are intended to result in the regular conclusion of contracts to be performed by a foreign enterprise, that enterprise should be considered to have sufficient taxable nexus in that country unless that intermediary is performing those activities in the course of a truly independent business.

If Action 7 is implemented, an agent acting in a country on behalf of an enterprise will create a PE where the agent "habitually concludes contracts, or negotiates the material elements of contracts, that are: (a) in the name of the enterprise, or (b) for the transfer of ownership of, or for the granting of the right to use, property owned by that enterprise or that the enterprise has the right to use, or (c) for the provision of services by that enterprise," unless the independent agent carve-out applies. But for this purpose, a new "independent agent" test will apply: Where a purported independent agent "acts exclusively or almost exclusively on behalf of one enterprise or associated enterprises," that person will no longer be an independent agent.

Article 5(4) of the current OECD Model Tax Treaty lists "specific activity exemptions," in which a PE is deemed not to exist where a company's activities in a given country are limited to those that are listed in that paragraph. These specific activity exemptions are generally meant to permit a multinational enterprise to conduct certain "preparatory and auxiliary" activities in foreign jurisdictions without creating a PE. For example, maintaining local warehouses for the storage, display, or delivery of goods is exempt.

The OECD, however, has expressed concern that the specific activity exemptions in the current tax treaties are used by multinational businesses to conduct significant business activities in foreign jurisdictions that exceed the exemptions' intended purposes. The OECD also expressed concern that multinational businesses were artificially fragmenting their operations among multiple group entities to qualify for the exceptions to PE status. As a result, the OECD has offered proposed revisions to Article 5(4) so all the specific activity exemptions would be subject to a preparatory or auxiliary condition.

The proposed revisions provide that activities have a "preparatory" character if they are carried on in the contemplation of the carrying on of the essential and significant part of the activity of the enterprise as a whole. An activity would be considered "auxiliary" if it is carried on to support, without being part of, the essential and significant part of the activity of the enterprise as a whole. "Auxiliary" activities are not meant to include any activity that requires a significant proportion of the assets or employees of the enterprise.

The proposed revisions also provide an anti-fragmentation rule (e.g., Article 5(4.1)), which essentially aims to prevent the artificial fragmentation of cohesive business operations between related parties to satisfy the preparatory and auxiliary exemption. The proposed rules would view the activities of related parties in combination, rather than in isolation, when determining whether the activities are preparatory and auxiliary.

Taxpayers that are currently using facilities (i.e., warehouses) in foreign jurisdictions for the purchase, storage, or delivery of goods should contact their tax adviser to address how the proposed changes, if adopted, might affect their tax exposure, including increased reporting and compliance responsibilities.


Every international enterprise, regardless of size or whether its existing or proposed structure is driven by tax considerations, will be affected if the G-20 adopts the changes to the definition of a PE proposed under Action 7. The changes may result in unintended adverse tax consequences for arrangements that Action 7 deems as unacceptable profit shifting, even though the structure may be driven by commercial, not tax, considerations.

Taxpayers carrying on business activities in tax treaty countries should contact their tax adviser to address how these proposed changes, if adopted, would influence their current operational structures and international tax planning.


Mark Heroux is a principal with the Tax Services Group at Baker Tilly Virchow Krause LLP in Chicago.

For additional information about these items, contact Mr. Heroux at 312-729-8005 or

Unless otherwise noted, contributors are members of or associated with Baker Tilly Virchow Krause LLP.

Tax Insider Articles


Business meal deductions after the TCJA

This article discusses the history of the deduction of business meal expenses and the new rules under the TCJA and the regulations and provides a framework for documenting and substantiating the deduction.


Quirks spurred by COVID-19 tax relief

This article discusses some procedural and administrative quirks that have emerged with the new tax legislative, regulatory, and procedural guidance related to COVID-19.