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BEPS: blurred lines between direct and indirect tax

On 5 October 2015, the Organisation for Economic Co-operation and Development (OECD) released its final recommendations on tax policies and treaties as part of its Base Erosion and Profit Shifting (BEPS) Project. Action 7 relates to preventing the artificial avoidance of permanent establishment (PE) status.  

This Action has caught the attention of corporate income tax professionals, but what does this mean (if anything) from the perspective of indirect taxes such as value-added tax (VAT) and goods and services tax (GST)?

Corporate tax PE and the impact of BEPS

Corporate income tax (CT) is generally chargeable on profits only to the extent that the business has a permanent establishment (PE) in the country to which the profits are attributable. The definition of PE is therefore crucial in determining whether a business must pay CT in a country.

In recent years, many jurisdictions have been concerned that multinational enterprises have been avoiding tax by artificially avoiding the creation of a PE. To address this, the final BEPS report includes recommended changes to the definition of PE.

The main changes center on preventing the avoidance of PE status through:

  • Using a local sales agent (such as through commissionaire structures)
  • Using specific-activity exemptions for warehousing, “preparatory and auxiliary” activities and similar items
  • Splitting up a contract (for example, by having several separate contracts covering subsequent months of a project or covering separate elements so that each individual contract does not in itself confer PE status)

The overall effect of the BEPS recommendations appears to be to lower the threshold for having a CT PE. But do these changes affect the VAT/GST position?


The concept of fixed establishment (FE) for VAT/GST is still a crucial factor in deciding whether (and where) the supplier is liable to account for VAT/GST on many cross-border services. In most countries, the establishment definition used for VAT/GST is slightly different from (and often broader than) the one used for CT.

If the supplier is found to have an FE, it is generally responsible for registering for VAT/GST and accounting for the tax in the country where it is established (effectively as a resident business). In the past, it has generally been accepted that to constitute an FE, a supplier must have both the human and technical resources necessary to provide/receive the services in question.

However, in the digital economy, human resources are becoming less necessary to providing cross-border services (e.g., in the cloud), causing this FE definition to be examined more critically. For example, some countries (such as Italy and Saudi Arabia) are exploring the concept of a “digital PE,” arising from a business’s online presence in that country (e.g., through online advertising to a local user base).

If this concept becomes widespread, many more digital businesses with no physical presence in a country are likely to be drawn into the local VAT/GST net, greatly increasing their compliance and reporting burden.

In addition, some EU Member States have interpreted the decision from the Court of Justice of the European Union (CJEU) in the case of Welmory (C-605/12, October 2014) to mean that a third party can constitute an FE for a supplier. On this basis, some Member States are now actively pursuing businesses that utilize assets or other resources of an affiliate or third party located in their local Member State.

  • Impact of BEPS PE changes on VAT/GST

    As the definition of a VAT/GST FE is generally different from a CT PE definition, you might think BEPS Action 7 is not relevant for VAT/GST. However, there are important points to note:

    • PE/FE interconnectivity

      Some countries will automatically deem a business with a PE to have a VAT/GST FE, and vice versa. EY recently carried out a survey across 67 countries on the interaction of VAT/GST FE and CT PE:

      • The tax authorities in 28% of the countries surveyed have the same definition for a CT PE as for a VAT/GST FE, including Argentina, the Czech Republic, South Korea and Switzerland.

      • Where a business has a VAT/GST FE, just under a third of countries would automatically treat the company as having a CT PE, including Greece and Turkey.

      • In 24% of countries surveyed, having a VAT/GST registration automatically results in a CT PE, including Brazil, Egypt, Kenya and Turkey. For an additional 17%, a VAT/GST registration would be considered an influential factor in deciding whether a business has a CT PE.

      • In 33% of countries surveyed, having a CT PE automatically results in a VAT/GST FE, including Australia, India and Portugal. For an additional 38%, a CT PE would be considered an influential factor in deciding whether a business has a VAT/GST FE.

      Because the CT PE definition can have a direct impact on the VAT/GST position in several countries, increased instances of a CT PE may lead to increased instances (or assumed instances) of VAT/GST FE.

      Furthermore, businesses in certain sectors (such as digital/services businesses) may consider that their greater risk area is VAT/GST, rather than corporate tax, and that BEPS should potentially be an indirect tax debate.

    • Business changes

      Any changes to the CT definition of PE may lead businesses to alter their operating models, change supply chains or shift business functions from one jurisdiction to another (especially for businesses operating “higher risk” practices, such as a commissionaire operating model, local warehousing, etc.). These changes almost certainly will have an indirect tax impact.

  • Implications for businesses

    Besides understanding the tax technical position when a change is introduced, businesses should consider a number of practical matters when any changes are anticipated, including:

    • Should the business model be reconsidered to accommodate the new PE environment (e.g., moving away from a commissionaire structure)?
    • If any supply chains are changing, do they need to be remapped for indirect taxes?
    • How should enterprise resource planning (ERP) systems be updated to reflect the changes?
    • Is there a reporting impact? For example, if the business was previously not established but will be now, the VAT/GST domestic reverse charge may no longer apply in certain countries.
    • Will there be any new indirect tax registrations required or additional/changing compliance obligations?
    • Will the input tax deduction mechanism change? For example, in some countries, you may not be entitled to register for VAT/GST if you are not established there. If you are not eligible to register, your means of recovering any local VAT/GST incurred on costs would be through a separate local claim (such as through the EU reclaim process). However, not all countries refund VAT/GST to nonresidents. And in countries such as Italy, Greece and Spain, the process might take years, even for EU claimants. For some businesses, this level of cost or cash flow delay may far outweigh the corporate tax benefits of not having a PE.
    • Is there a mismatch in the recognition of business establishments for direct and indirect tax purposes? If so, businesses may need to account for sales and purchase transactions in different countries for direct and indirect taxes. This would immediately impact tax determination logic, accounting and reporting, and might raise red flags with tax authorities comparing country-by-country reporting documentation with VAT returns.
    • Does the business need to obtain rulings from the tax administration in countries with an unclear distinction between PE and FE?
    • What is the likely impact of regulatory and contractual changes?
    • Are there any operational or customs benefits from establishing a PE for non-EU entities operating in the EU?
  • What should businesses do?

    Given the potential changes as a result of BEPS, businesses should introduce a governance framework that takes a structured and methodical approach to managing the impact and risk (as much as possible) of these types of business changes. It is vital that the VAT/GST considerations are properly integrated into the wider BEPS business action plan, including the following areas:

    • Have tax teams closely engage with their legal and commercial counterparts so that the growing overlaps covered by more than one tax or business area do not fall through the cracks
    • Proactively monitor changes — not just VAT/GST changes, but wider tax, legal, regulatory and commercial changes. Gone are the days when ignorance might have been an acceptable excuse
    • Perform impact assessments, including data analytics to understand the potential financial and risk implications
    • Lobby and work with governments and tax authorities to highlight the potentially unintended consequences for other taxes or business areas, as well as the practical challenges
    • Examine whether to proceed with any proposed changes to operating models or supply chains, and whether to do business in new territories where the potential cost, risk or compliance burden outweighs the commercial upside
    • Implement or update processes and controls (both human and automated)


The BEPS Actions and any possible changes to the definition of PE are not only direct tax issues. Increasingly, multinational businesses need to be mindful of the interaction between different forms of taxation and between tax and their broader business issues. These connections are likely to become stronger.

Already, we are seeing a shift in direct taxation toward taxation at the place of consumption — traditionally a largely indirect tax concept. As the BEPS Project evolves, how long it will be before distinctions between direct and indirect taxation blur and disappear altogether?


EY - Charles Brayne Charles Brayne
+44 20 7951 6337

EY - Rosie Higgins Rosie Higgins
+44 20 7980 9194

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