ATC 2012: Scrutiny of permanent establishments in Africa

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The minute a foreign business ceases to trade with a country and begins to trade within it, it crosses the Rubicon from a tax perspective. To set up shop in a country, or, to be more technically precise, to create a permanent establishment in a country, creates a taxable presence in that foreign country. Needless to say, the permanent establishment concept is central to the determination of a multinational's global tax liability as tax certainty is of key importance in respect of any cross-border investment. At the same time, however, the dynamic and diverse nature of enterprise means that it is often difficult to determine whether it meets the required level of permanence or fixedness, creating fertile ground for dispute between multinationals and tax administrations, says Ide Louw, Associate Director, International Tax, Ernst & Young.

Speaking at the firm’s annual Africa Tax Conference, Louw said uncertainty surrounded the permanent establishment concept under even the best of circumstances, such as where the countries concerned have a double tax treaty and follow established principles, such as those of the OECD or the United Nations. “In some African jurisdictions, however, familiarity with, or commitment to, such principles cannot be assumed. Despite this, the permanent establishment concept will likely be used increasingly in such jurisdictions as a basis for taxing the profits of companies doing business there.”

Louw says this makes it prudent for companies, as their businesses in Africa expand or change in response to market needs, to remain alive to the principles that may strengthen their position in dealing with African tax administrations.

There are a number of common scenarios, he says, where international support exists for the assertion that a permanent establishment, or taxable presence, is not created. “It often occurs for example, that a company will not send its own employees to work on an offshore project, but will enlist the services of in-country sub-contractors. The question arises of whether the activities of the sub-contractor would create a taxable presence for the main contractor. In certain circumstances, there will be strong support for the view that unless the sub-contractor’s personnel is actually supervised, controlled or given directions by the main contractor, the main contractor will not have created a permanent establishment through the use of sub-contractors.”

There are of course numerous ways in which companies effect distribution of their goods, but the use of what is known as a “commissionaire”, a civil law concept, which solicits and negotiates orders and contracts in its own name, is a potentially useful vehicle often found in Europe. It has been held by the French (Zimmer Ltd.) and Norwegian (Dell DUF) courts that such an arrangement does not create a taxable presence for the company whose goods the commissionaire sells. “Although this principle has not been officially confirmed in any African country, indications are that the use of this type of vehicle could mitigate the risk of creating a permanent establishment in certain African jurisdictions. Local advice should however be sought, as these concepts are not easily understood”, Louw says.

At the same time, warns Francis Kamau, Associate Director in the Tax department of Ernst & Young’s Kenya office, companies should be wary about replicating in African countries the complex structures that they may have in place in the developed world. “In Kenya, for example, the definition of permanent establishment is four lines long and appears in legislation that dates from 1974. It is a challenge for the revenue authorities to apply this law to the complexities of modern commerce, so it is important to keep things as simple as possible. Generally, if you are making money in Kenya, the authorities are going to expect to see a presence, they are going to expect a company to be registered for tax purposes.”

So instead of trying to avoid a taxable presence, says Kamau, it may be wiser for businesses to resign themselves to establishing one and making its activities very clear in the incorporating documents. “This reduces the risk that the authorities will apportion unrealistic profits to the enterprise.”

The message is that while African tax authorities are more determined than ever to ensure that multinationals pay their dues, there is not yet much certainty or consistency around when a taxable presence arises. Companies can help to develop certainty by analysing their tax exposure according to best practice and international guidelines and articulating this as clearly as possible in dealing with African tax administrations.