Action 7 under the OECD’s BEPS project has resulted in a significant expansion of the definition of a permanent establishment (PE). Importantly, the circumstances in which a dependent agent PE (DAPE) can be created have been significantly widened.
Furthermore, the list of exempted activities are now subject to an overriding precondition that they be “preparatory or auxiliary” in nature. New guidance on profit attribution has also been issued.
Many countries have already begun introducing the changes into local legislation, and the potential impact on firms operating in the asset management sector is significant. The changes are expected to have the most impact on an asset manager’s marketing, capital raising, distribution and asset management functions. Furthermore, additional documentation requirements under Action 13 may increase PE vulnerability / exposure across the asset management value chain.
The definition of DAPE has significantly widened, and a new concept has been introduced. Rather than focusing on the agent's authority to conclude contracts, the test is that the agent habitually concludes contracts, or habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise.
The changes are aimed at tackling the use of marketing arrangements or similar structures to circumvent the existing definition of a PE. For asset managers, the phrase “habitually concludes contracts” will affect situations in which the conclusion of a contract directly results from actions that a local distributor performs in his home country on behalf of the asset manager, even though the contract is not concluded by the local distributor.
This includes the actions of an asset manager’s sales force (including any capital raising personnel or marketers), for example, when a marketer solicits (but does not formally finalize) mandates which are sent directly to the lead asset manager and where the lead asset manager routinely approves the mandate. In contrast, when a marketer merely promotes and markets asset management products or services, the marketing activity does not directly result in the conclusion of contracts, even though sales may significantly increase as a result. An example of how the DAPE threshold changes will affect an asset manager with global distribution functions is presented below.
Consider a US-parented asset manager with American, European, and Asian distribution operations. The PE treatment by country is represented by Scenario 1 (pre BEPS) and Scenario 2 (post BEPS).
In summary, the adoption of Action 7 changes in countries such as Germany, the Netherlands and France will potentially result in new PEs for an asset manager operating in these jurisdictions despite the fact that the functional nature of the distribution activities in these countries have not changed.
In addition, Action 7 limits the definition of an agent as “independent”. Under the new rules, independent status is less likely when the agent acts exclusively or almost exclusively for one or more closely related enterprises. This will be of particular importance to distributors that act exclusively for a related party asset manager.
The OECD has also released draft guidance on the attribution of profit to a PE. The new guidance takes into account changes to the definition of a PE, as discussed above, and more broadly to the Transfer Pricing Guidelines under BEPS. Given that the guidance is largely focused on non-FS businesses, below we highlight only the elements that will be of relevance to asset managers.
Firstly, there may be unintended consequences of the proposed profit attribution rules if there is a deemed PE. Whether this is considered a branch or legal entity, there will be implications for the asset manager regarding a whole host of taxes, including whether withholding and indirect taxes apply. In addition, if a branch is incorporated, this may result in differences in applicable tax rates and the benefit of previous losses.
Under the new guidance, there may also be a higher incidence of “split KERTs”, given the subjective nature of how the guidance is applied by different countries and in recognition of the fact that many asset managers’ operations are becoming increasingly fragmented across personnel, functions, and locations. Split KERTS will inevitably result from multi jurisdiction challenges where tax authorities’ interpretations of the new guidance and what constitutes a KERT may differ.
Any increase in split KERTS as a result of Action 7 interpretation may also further complicate the application of BEPS Actions 8 to 10. The latter tackle distinctions between the ownership of assets, such as capital, and the management of the corresponding risk. If an entity only provides capital while another entities performs the KERT functions needed to deploy that capital (such as managing assets), the above-routine profits should be recognized in the KERT entity. Where there are split KERTs, perhaps due to a deemed PE, there may be further disputes regarding where the above-routine profits should be recognized.
Asset managers should also consider the impact of increased PE risk on BEPS Action 13 TP reporting requirements. The acknowledgement and descriptions of taxable operations by jurisdiction should be consistent with any external publicly available data such as social media, PPMs or investment manager league tables that are available to NGOs and tax authorities.
As of January 2018, more than 70 countries have signed the multilateral instrument to incorporate at least parts of BEPS (including Action 7) within bilateral tax treaties in a consistent and efficient manner. Accordingly, a number of countries have been independently amending their tax treaties to bilaterally adopt and incorporate specific Action 7 changes. This includes countries with significant asset management activity, such as the US and UK.
Given the observed movement toward adoption of elements of BEPS Action 7 by various countries, asset manager should act now to review their structures, global footprints and monitor latest PE developments in relevant jurisdictions. In addition, BEPS-proof governance for distributors, "flying marketers" and senior IM personnel should be established and reviewed for consistency, as well as corresponding profit attribution methodologies.