An Analysis of the Proposed Amendments to the PE Definition in Art. 5(4) of the Model Tax Convention

Henriette Tvedeskov Jantzen & Torben Bruun-Jensen

Student thesis: Master thesis


As a result of technology development, the ways in which multinational enterprises (“MNEs”) are structured have changed. Hence, it is possible for MNEs to operate digital business models at a global level with a minimum of physical presence and without creating a permanent establishment (“PE”) under the current PE definition. OECD has agreed to modify Art. 5(4) of the Model Tax Convention to prevent the artificial avoidance of PE status and to ensure that core activities cannot inappropriately benefit from this provision. The purpose of this thesis is therefore to analyse the proposed amendments in Action 7.
The analysis states that MNEs are exempted from having a PE if the activities that are carried out in the source state are of a “preparatory or auxiliary” character. However, activities that are an essential and significant part of the core activities are not preparatory or auxiliary and will create a PE. The proposed amendments in Action 7 introduce new criteria that will create a PE such as the use or maintenance of a “very large” warehouse with a “significant” number of employees. The maintenance of a fixed place at the “disposal” of the MNEs or where the MNEs are allowed “unlimited access” will also create a PE. The aim of the new anti-fragmentation rule is to restrict the scope of Art. 5(4) and applies to “complementary functions that are part of a cohesive business operation”.
The functional analysis in the thesis concludes that activities carried out by online retailers, such as procurement, warehousing and marketing, cannot be regarded as preparatory and auxiliary activities. Due to the high risk that such activities will create a PE, online retailers are likely to make adjustments to their existing business models in order to adapt to the new PE definition. Finally, the thesis finds that the proposed amendments in Action 7 do not correspond with the goals set forth by the OECD. The unclear criteria create uncertainty and unpredictability for tax authorities and MNEs and seem to result in additional administrative costs and increasing risks of disputes, double taxation and double non-taxation.
The thesis concludes that the proposed amendments in Action 7 should be adjusted in order to provide greater certainty and predictability about the interpretation of “preparatory or auxiliary”. For this reason, the thesis suggests to introduce three cumulative criteria to determine whether the activities are of a preparatory or auxiliary character. If the profit of the activities is below a greatest lower bound, the activities are important for any business and are not permanent in nature, then the activities are preparatory and auxiliary.

EducationsMSc in Commercial Law, (Graduate Programme) Final Thesis
Publication date2017
Number of pages134
SupervisorsPeter Koerver Schmidt