International project management: Permanent establishments in ambush
Cyril Maucour, Stéphane Gasne and Jessica Benchetrit of DS Avocats consider how the BEPS project implementation by the Multilateral Instrument exacerbates tax and employment problems related to the international mobility of employees.
The positions adopted by the OECD since the BEPS project was launched in 2015 and implemented by the Multilateral Instrument (MLI), have the important objective of limiting the extent to which multinational companies resort to tax planning strategies. These positions do, however, have some secondary effects. Most notably, by disrupting the way value is tax assessed, they destabilise the tax structures set up to complete large-scale international projects requiring the deployment of key employees to the country in which the investment is made.
This strategy is the result of the OECD’s intention to look beyond contracts and legal structures and to tie value to where it is created and to the key persons in charge of making decisions on business risks.
The common denominator of all large-scale international projects – such as the building of transport and telecommunications infrastructure, water and waste treatment plants, mineral and hydrocarbon extraction and treatment plants, or energy production facilities and energy transmission and distribution networks – is that they all require project engineering and management to be provided by an industrial sponsor with significant technical know-how. This sponsor must necessarily deploy its capabilities where the project is being developed and generally for an extended period of time.
Similarly, these projects also systematically require the transfer of knowledge and technology to those acquiring the facilities, meaning that the key employees of foreign sponsors are often sent on a long-term basis to train those operating the facilities. This transfer of knowledge, which relies on the expatriation of project managers and other key employees of industrial companies to host countries, is one of the most significant levers of development, especially in emerging countries.
Lastly, the public and private organisations in charge of financing these projects often impose conditions, such as minimum local content requirements, a maximum level of sponsor fees attributable to where the project is taking place, etc. These are essentially of a legal nature, as they form part of contracts, but there is a discrepancy between them and the key staff deployment principles set out by the OECD. This is particularly true of the requirements imposed by export credit agencies (ECAs) that only support projects initiated by operators from the source country to the extent that economic activity in the source country benefits from the same support, and accordingly require that a minimum portion of the project procurement takes place in the source country.
Structuring the international deployment of key employees to the country where the project is executed is an issue that must be examined very carefully before their departure, in order to ensure that the work they carry out locally is correctly assessed from a tax perspective, whether this is done through an operational subsidiary or a permanent establishment. The functions of these employees must also be correctly defined in order to avoid them being qualified as dependent agents and, lastly, in order to ensure that the value attributable locally complies with the arm’s-length principle.
It is unfortunate that the OECD has not updated its analysis of the terms and conditions of employee secondment (service or intra-group) in order to set the guidelines on the notion of controlling deployed staff and thus secure the management, supervision and receipt of works.
At present, the international mobility of employees poses many tax and employment problems, with the notion of employee control and power given to employees at the centre of these issues. Whether hosted by an existing or newly incorporated subsidiary, seconded employees may create a risk of the subsidiary being deemed a permanent establishment, and of challenges to whether its remuneration complies with the arm’s-length principle.
These issues also centre on the interactions between these employees and the other project stakeholders and in particular with the members of the consortium created to co-manage the project.
The impact of international mobility on group subsidiaries
This section looks at how to cover the risk of permanent establishment status and adjustment to transfer prices. The simplest case is where a single international group is involved in a large-scale and long-term international project that involves project management services being provided at the place of execution.
Project managed by a local subsidiary
The simplest scenario is one where the group already has a subsidiary in the country in question and uses it as a sub-contractor for local production. The execution of the project does not have an impact on the normal activity of this subsidiary, which directly and independently manages the project using its own employees.
Any corresponding international deployments would be limited in this case, both in terms of duration and scope. Nevertheless, the subsidiary must be the only one controlling the employees, with no direction provided by the foreign company, which could then be considered to have a fixed place of business through its subsidiary (see Supreme Court decision in France Interhome).
Project managed by a key employee seconded to the local subsidiary
The situation becomes more complicated when the project requires the foreign company to deploy a key employee to the site because the work that must be carried out locally does not fall within the traditional scope of business of the local company (for example, distributing and installing new equipment, renovating industrial production equipment, setting up a new production unit, etc.).
Risk of permanent establishment status
In this case, the notion of control of the subsidiary is crucial for determining if there is a risk of it being qualified as a permanent establishment or not. You must therefore ensure that the key persons’ activities are properly structured from a legal and operational perspective.
If they continue to be controlled by their foreign employers both as a matter of fact and of law, they will be considered to be outside the scope of the subsidiary from a contractual and operational perspective and as such may be deemed to constitute a fixed place of business for the foreign employer, which defines a permanent establishment.
According to Article 5 of the OECD and UN model tax conventions, a company is considered to have a permanent establishment when it has a fixed place of business through which it carries out all or a portion of its activity. Furthermore, some activities are expressly singled out to constitute a permanent establishment by their very nature, in particular work sites that are active for more than 12 months.
In its commentary, the OECD clarified this notion by indicating that it must be assessed in terms of the human and material resources provided in the host country in order to carry out the activity.
The question that must therefore be asked is whether the employees deployed to the site constitute a permanent establishment according to these provisions. The commentary provided by the OECD, in particular in relation to intra-group secondments, allows us to shed some light on these matters. The OECD provides a list of criteria for this purpose, allowing us to assess the employer/employee relationship as part of an intra-group secondment as well as this notion of control. The criteria refer both to administrative control and to operational control, which seems more important in defining who controls the employee.
Criteria for identifying administrative control:
Who determines the employee’s annual leave and timetable?
Who controls the place where the work is carried out, and who is responsible for it?
Criteria for identifying operational control:
Who is authorised to instruct the employee on how work must be carried out?
Is the employee’s remuneration directly invoiced by the formal employer to the company to which the services are provided?
Who provides the employee with the materials and equipment required to carry out the work?
Who determines which employees carry out the work and the skills they must have?
Who has the right to choose the employee that will carry out the work and terminate to contractual relations entered into with the employee for the purposes of this work?
Who has the right to impose disciplinary sanctions related to the employee’s work?
If the answer to these questions is the company hosting the intra-group secondment, then it should be able to avoid the risk of being deemed a permanent establishment of the source company.
Necessary update in TP policy
Beyond the risk of permanent establishment status, this situation also illustrates the difficulties encountered in terms of transfer prices. An employee managing a project at a subsidiary over the short or long term may have an impact on the subsidiary’s functional profile, especially if this person is considered a key employee of the group.
The initial functional analysis should therefore be updated to take into account this employee’s presence and the remuneration of the subsidiary should be adjusted so that it complies with the arm’s-length principle and can cover all services provided by the subsidiaries, and therefore by the employee.
However, given that employees could be posted short-term (a single financial year, for example), and that they could be there at different times, the impact on the functional analysis would be only temporary. The question faced by international groups is therefore whether their transfer pricing (TP) policy should be changed every time key employees are deployed and how to assess this impact in respect of the length of the secondment.
These TP issues are even more complex as they are linked to project financing issues (the notion of local participation to be taken into account) and to issues related to the transfer of knowledge and technologies from the key employees managing the project.
Increased risk of qualification as a dependent agent
The situation can become even more complex if the functions of the person deployed as project manager extend beyond the simple supervision of the subsidiary’s employees, as part of activities that have more significant value added, and if this person is in charge of project management and relations with third parties, such as managing client relations, monitoring work, producing specifications, amending contracts, managing relations with suppliers, managing procurement, etc.
In this case, the functions and decision-making powers required to manage and bind the foreign company should be structured in such a way as to avoid the qualification as a dependent agent.
The notion of dependent agent, as defined in Article 5 of the OECD and UN model conventions, has actually been expanded recently by the MLI, which provides that a dependent agent constitutes a permanent establishment if it has the power to negotiate contracts, even if it does not actually conclude them (“[the person] 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”).
In France, the Supreme Court has ruled, in its December 11 2020 judgment on the Conversant case related to the application of the Franco-Irish agreement, that the power to set models, negotiate and have an impact on the conclusion of contracts could lead to being qualified as a dependent agent, despite the existence of a subsidiary where the employees carried out their duties.
This situation would have the same consequences in terms of TP as described above, but in this scenario the implications would be more significant given that the activity carried out by the key person would make an additional contribution to the subsidiary, thus leading it to perform functions outside its normal business activities and creating a higher value added that would affect its functional profile.
This change could therefore have an impact on its remuneration, but especially on the amount of profit to be attributed to this subsidiary, which would, as a result of this new activity, become a co-entrepreneur even though it had previously only carried out routine activities.
Projects carried out by co-contracting international group consortiums
Frequently, for large-scale projects, several international groups collaborate to fulfil project requirements and complete them jointly through a consortium or joint venture.
In principle, in the case of several independent groups, TP rules do not apply; instead, companies freely decide among themselves how to allocate the profits or losses that are generated.
However, in the case of a project executed jointly by all of the companies, the international mobility issues and tax implications (risk of permanent establishment and TP) remain relevant and are more complex than in the case presented above, where a single group executes the project.
In this type of structure, one company is usually identified as the leading partner and acts as the authorised representative of the group and manages and supervises work, for example, either from the foreign company or through a local structure set up for this purpose.
The issue will therefore be with the role of the persons acting as project managers at the local structure and with their interactions with the other employees, in particular the employees of companies in the consortium.
If the person acting as a project manager on behalf of the company acting as project leader controls the employees of another company that is a member of the consortium at the local work site, then this could lead to the other company being deemed to have a permanent establishment, and the rules presented above related to intra-group secondment would not apply.
Companies that are members of a consortium cannot apply the rules governing intra-group secondment (employee seconded to a group subsidiary) or service secondment (employee seconded directly to a client) that apply to independent companies. When needing to post employees to a local work site, these companies find themselves in a complex situation where they incur a high risk of acquiring permanent establishment status and where TP regulations do not apply.
In a context where international projects require an increasing amount of varied and specific technical experience, and where skills must be provided by several groups, would it not be reasonable to introduce a new way of seconding employees? A ‘project secondment’ type of arrangement would allow foreign companies that are members of a consortium to second their employee for various periods of time to a local structure in charge of managing the project, while avoiding, similarly to intra-group secondments, the risk of permanent establishment status and adjustment to transfer prices.
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Cyril Maucour is a tax partner at DS Avocats. He is known for his expertise in international taxation and TP matters, and regularly advises French companies in their international operations and assists foreign groups in their activities in France.
Cyril is often involved in the structuring and documentation of their cross-border operations. He advises multinational companies, as well as small and medium-sized companies.
Cyril holds a master’s degree from Paris Nanterre University and a LLM from Golden Gate University.
T: +33 1 53 63 50 00
Stéphane Gasne is a project finance partner at DS Avocats. He is active in project financing, project development and infrastructure construction.
Stéphane has almost 20 years of experience on major projects across Europe, Africa and Asia, working with major players in the energy and construction sector, as well as development banks, infrastructure funds and sponsors.
Stéphane holds degrees from Sciences Po and Paris 2 Panthéon-Assas University.
T: +33 1 53 67 50 00
Jessica Benchetrit is a senior associate with DS Avocats. She joined the firm in 2019 and regularly works on international taxation and TP issues.
Jessica is a graduate of Paris-Est Créteil University and holds a master’s degree in tax law. After several internships in international taxation at EY and CMS Francis Lefebvre Avocats, she began her career as a lawyer within Bignon Lebray.