1. OECD has made certain changes in July,2005 in its Commentary on several Articles of the model treaty . In this issue we shall focus on the changes made in the commentary on Article 5, namely "Permanent Establishment" and its impact.

1.1 We set out below the changes in the paragraphs of the commentary and its impact paragraph wise.

2. Paragraph 33 of the Commentary on Article 5 replaced by the following:

"33. The authority to conclude contracts must cover contracts relating to operations which constitute the business proper of the enterprise. It would be irrelevant, for instance, if the person had authority to engage employees for the enterprise to assist that person’s activity for the enterprise or if the person were authorized to conclude, in the name of the enterprise, similar contracts relating to internal operations only. Moreover the authority has to be habitually exercised in the other State; whether or not this is the case should be determined on the basis of the commercial realities of the situation. A person who is authorized to negotiate all elements and details of a contract in a way binding on the enterprise can be said to exercise this authority "in that State", even if the contract is signed by another person in the State in which the enterprise is situated or if the first person has not formally been given a power of representation. The mere fact, however, that a person has attended or even participated in negotiations in a State between an enterprise and a client will not be sufficient, by itself, to conclude that the person has exercised in that State an authority to conclude contracts in the name of the enterprise. The fact that a person has attended or even participated in such negotiations could, however, be a relevant factor in determining the exact functions performed by that person on behalf of the enterprise. Since, by virtue of paragraph 4, the maintenance of a fixed place of business solely for purposes listed in that paragraph is deemed not to constitute a permanent establishment, a person whose activities are restricted to such purposes does not create a permanent establishment either."

2.1 Observations

This amendment is in connection with Agency P. E. and the "authority to conclude contracts". It has been clarified that the authority to conclude contracts refers to operations which constitute the business proper of the enterprise i.e.: the core activities of the enterprise. If the authority is relating to trivial matters such as appointment of employees for the enterprise or some internal operations, they do not constitute "core activity".

Authority should be habitually exercised and it must be to negotiate all matters in detail in such a way that it has binding effect on the enterprise. (It should legally bind the enterprise)

Mere attending in negotiations is not adequate to bind the enterprise.

Merely having a fixed place is not adequate to conclude that it results in Permanent Establishment.

3. Paragraphs 41 and 41.1 of the Commentary on Article 5 replaced by the following:

"41. A parent company may, however, be found, under the rules of paragraphs 1 or 5 of the Article, to have a permanent establishment in a State where a subsidiary has a place of business. Thus, any space or premises belonging to the subsidiary that is at the disposal of the parent company (see paragraphs 4, 5 and 6 above) and that constitutes a fixed place of business through which the parent carries on its own business will constitute a permanent establishment of the parent under paragraph 1, subject to paragraph 3 and 4 of the Article (see for instance, the example in paragraph 4.3 above). Also, under paragraph 5, a parent will be deemed to have a permanent establishment in a State in respect of any activities that its subsidiary undertakes for it if the subsidiary has, and habitually exercises, in that State an authority to conclude contracts in the name of the parent (see paragraphs 32, 33 and 34 above), unless these activities are limited to those referred to in paragraph 4 of the Article or unless the subsidiary acts in the ordinary course of its business as an independent agent to which paragraph 6 of the Article applies.

3.1 Observations:

This amendment is also in regard to Agency PE.

Circumstances where a parent company is said to have a PE

1. Where parent has at its disposal the premises/ place belonging to its subsidiary and such place constitutes fixed place of business of the parent through which the parent carries on its own business, it constitutes PE of the parent.
    

2. Where subsidiary undertakes the activities for its parent and habitually exercises the authority to conclude contracts in the name of the parent, unless the subsidiary acts in its ordinary course of its business as an independent agent. In other words even if the subsidiary does any work for the parent as an independent agent, it will not make it PE of the parent. The subsidiary should not be dependent upon the parent for such activities. It should have sufficient business of that kind on its own.

4. Para 41.1 of the commentary on Article 5 amended as follows:

"41.1The same principles apply to any company forming part of a multinational group so that such a company may be found to have a permanent establishment in a State where it has at its disposal (see paragraphs 4, 5 and 6 above) and uses premises belonging to another company of the group, or if the former company is deemed to have a permanent establishment under paragraph 5 of the Article (see paragraphs 32, 33 and 34 above). The determination of the existence of a permanent establishment under the rules of paragraphs 1 or 5 of the Article must, however, be done separately for each company of the group. Thus, the existence in one State of a permanent establishment of one company of the group will not have any relevance as to whether another company of the group has itself a permanent establishment in that State."

4.1 Observations

This amendment is also in regard to Agency PE. Same principles as applicable to parent subsidiary as explained above are applicable in respect of a multinational group. The presence of PE test should be with reference to each of the companies separately in the group. The existence of PE in one state for one of the companies in the group is not relevant for all other companies in the group. In other words just because one of the companies becomes PE, other companies do not automatically become PEs.

5. The following new paragraph 42 inserted immediately after paragraph 41.1 (see above change) of the Commentary on Article 5

"42. Whilst premises belonging to a company that is a member of a multinational group can be put at the disposal of another company of the group and may, subject to the other conditions of Article 5, constitute a permanent establishment of that other company if the business of that other company is carried on through that place, it is important to distinguish that case from the frequent situation where a company that is a member of a multinational group provides services (e.g. management services) to another company of the group as part of its own business carried on in premises that are not those of that other company and using its own personnel. In that case, the place where those services are provided is not at the disposal of the latter company and it is not the business of that company that is carried on through that place. That place cannot, therefore, be considered to be a permanent establishment of the company to which the services are provided. Indeed, the fact that a company’s own activities at a given location may provide an economic benefit to the business of another company does not mean that the latter company carries on its business through that location: clearly, a company that merely purchases parts produced or services supplied by another company in a different country would not have a permanent establishment because of that, even though it may benefit from the manufacturing of these parts or the supplying of these services."

5.1 Observations

This amendment also relates to Agency PE.

Members of multinational group providing services (management services) to another company in the same group as part of its own business. In such a situation where the services provided are not at the disposal of the other company and is not the business of the other company, it does not constitute PE of the other company to whom services are provided. Thus mere provision of common services does not make the user of such services PE of the company using such services.

Authors’ Comments: The changes are clarificatory in nature. The OECD commentary has persuasive value before the judicial forums. These changes should be kept in mind because they can be usefully presented before the judicial forums while making submissions. They are also useful in structuring cross border transactions / entities.