Taxable Nexus: Moving Toward an Economic Approach
Corporate tax professionals might consider OECD approach

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In this article we discuss the global trend toward taxing foreign companies with significant business abroad that have managed, by dodging local permanent establishment requirements, to remain outside the tax net in the countries where they do business. In particular, we discuss the recent trend whereby taxing authorities have significantly expanded the boundaries of taxable nexus by redefining it to include an economic dimension that goes beyond traditional geography-based approaches. We give an overview of recent developments in Organisation for Economic Co-operation and Development (OECD) member states and some unilateral initiatives taken recently.

Permanent establishment (PE) may be the most recognizable concept in international taxation. The concept harks back to a nineteenth-century tax treaty between Austria-Hungary and Prussia. Although as a concept PE has been subject to numerous changes over time, its purpose has remained constant: to serve as a threshold for allocating taxing rights on profits realized by a company outside the borders of its home country.

The rapidity with which the modern economy has outpaced even the most up-to-date conceptions of PE (still grounded in the era before anti-base erosion and profit shifting initiatives) may have, to some extent, facilitated the global tax strategies of multinational enterprises (MNEs) to prevent their foreign economic activities from ever hitting the threshold that would trigger the establishment of one or more local PEs overseas. To combat these artificial avoidance strategies, the OECD in 2015 published the Report on Action 7 of the BEPS Action Plan (Preventing the Artificial Avoidance of Permanent Establishment Status), hereafter Action 7. The OECD recommendations in Action 7 focus on changes in the OECD’s definition of PE and aim to prevent MNEs from escaping the reach of foreign tax authorities through the use of artificial avoidance strategies.

Changes in the OECD Approach

To rightfully relocate the taxing rights on profits realized abroad, Action 7 focuses particularly on artificial avoidance of PE status through commissionaire arrangements and similar strategies; the artificial avoidance of PE status through specific activity exemptions; and other strategies, such as splitting up contracts, to artificially avoid OECD member states’ attempts to establish PE.

Foreign enterprises can be regarded as having taxable presence in a country through 1) physical nexus or 2) agency PE, the actions in the country of persons dependent on the enterprise. Under the pre-BEPS definition, agency PE occurs when a person, other than an independent agent, has been granted power of attorney to regularly make contracts in a country on behalf of a foreign principal.

With an eye toward evading the establishment of agency PE, one of the most common tax strategies MNEs employ to avoid or reduce taxable nexus abroad is to implement commissionaire arrangements. A commissionaire concludes sales contracts with customers in its own name but actually on behalf of the foreign principal. A key trait of a commissionaire is that it does not take title to the goods or services that it sells in the local market. The commissionaire assumes limited risk, performs only limited functions, and employs its own assets only minimally; rather, the foreign principal assumes responsibility for most of the risk, performance of functions, and investment in the local market. The commissionaire receives only limited remuneration.

That said, under the commissionaire arrangement, the foreign principal does not become liable for taxes on local profits in the country where the sales occur, because the commissionaire acts in its own name without legally binding the foreign principal to those sales. Absent the creation of agency PE in that country, the foreign principal counts the sales profits generated abroad in its own home country.

Under Action 7, the OECD has lowered the threshold for determining that agency PE has occurred. According to Action 7, foreign principals in a commissionaire arrangement will no longer remain outside the reach of local tax authorities merely because the commissionaire did not legally bind the foreign principal. What matters is whether the foreign principal has a person acting abroad on its behalf who habitually concludes contracts or plays a principal role leading to the conclusion of relevant contracts.

With an eye toward evading the establishment of agency PE, one of the most common tax strategies MNEs employ to avoid or reduce taxable nexus abroad is to implement commissionaire arrangements.

Another way MNEs have avoided PE has been through the specific activity exemption, which excludes certain activities, such as warehousing, from creating a PE. The rationale for excluding these activities pre-BEPS was that business models typically considered them low-value-adding activities from which little profit could be extracted. Since complying with tax obligations for such low-profit activities would create what would seem an unnecessary burden, prior to BEPS low-value-adding activities were excluded from creating a PE.

Now, however, seismic shifts in modern business practices mean that activities like warehousing are no longer by definition low-value-adding. The competitive power and profitability of online marketplaces and other forms of e-commerce depend on factors such as “time to door” and last-mile distribution. From an economic standpoint, warehousing thus has become crucial to many current business models.

To respond to this shift, Action 7 of BEPS aims to lower the threshold for creating a PE and thus the threshold for creating taxable nexus. According to Action 7, the specific activity exemption will nevertheless be extended under the condition that these activities are merely preparatory or auxiliary to the business as a whole. In other words, if a foreign company carries out activities in a country, and these activities qualify within the scope of the specific activity exemption, these activities will create a PE for the foreign company if these activities constitute a core activity, not an auxiliary one.

Direct Impact to U.S. MNEs?

Most local governments will be required to update their domestic tax legislation in order to enable local authorities to rightfully claim taxing rights based on, for example, post-BEPS understandings of PE. In addition, double tax agreements should be updated accordingly to recognize that certain fact patterns constitute a PE under a double tax agreement and consequently allocate taxing rights to the state in which the PE is located.

Although updating local domestic tax legislation may already be burdensome and lengthy, negotiating and updating bilateral tax treaties by each and every government will generally be an even bigger challenge. To facilitate the implementation of Action 7 and other BEPS action items into all double tax agreements, and to avoid the necessity that all local governments will have to enter into treaty negotiations on a per-treaty basis, the OECD invented the multilateral instrument (MLI).

The MLI is essentially a master treaty providing countries with a set of choices for implementing Action 7 and other BEPS initiatives in their bilateral tax treaties. Tax treaties between governments will be updated based on the choices each country makes in the MLI. However, this update will be effective only if both contracting states have made the same choice, i.e., they have “matched.”

By way of illustration, if State A elects to amend the specific activity exemption to align with Action 7 (that is, if State A wishes to amend its double tax agreements so that the specific activity exemption will become subject to a preparatory/auxiliary condition), and State B, a state that has concluded a double tax agreement with State A, does not opt to make the specific activity exemption subject to a preparatory/auxiliary condition (i.e., State A and State B do not match), then nothing will change in this aspect of the tax treaty between State A and State B.

More than a hundred jurisdictions signed up for the MLI. As a result, over 2,000 bilateral double tax agreements are expected to be updated in the near future. The United States is not one of these jurisdictions, and therefore the bilateral tax treaties between the United States and other member states will not be updated on the basis of the MLI. But this doesn’t mean by any stretch of the imagination that the MLI is irrelevant to U.S. MNEs. Even though U.S. entities themselves would not be confronted with the impacts of the MLI, their overseas subsidiaries in most cases will. In addition, U.S. entities may increasingly be confronted with local tax authorities searching for opportunities to broaden the tax base according to their own (updated) domestic tax legislation, whether or not this attempt is fully supported by the taxing rights granted under the relevant double tax agreement.

From Physical Presence to Economic Presence

Action 7 covers only physical presence abroad, whether through a fixed place of business or an agent. Action 7, therefore, does not cover companies operating abroad, with no local physical presence, through digital means (that is, companies operating in the digital economy), a fact that the OECD has recognized in its 2015 report, Action 1 of the BEPS Action Plan, Addressing the Tax Challenges of the Digital Economy (hereafter Action 1).

Although some observers consider Action 7 far-reaching and groundbreaking, others could plausibly take the view that it expands “taxable nexus” only by including certain forms of previously excluded physical presence.

The same cannot be said of the OECD’s intentions for the taxation of the digital economy. They are considerably more revolutionary. This shift in focus on the taxation of the digital economy more or less follows from the idea (or perhaps even the conclusion) that current tax rules no longer fit the digital context and lead to decreased competitiveness and declining state budget revenues across the European Union. In some cases, this is also substantiated by a sort of moral appeal: that corporations should pay their fair share.

Given current developments, we expect this focus on the digital economy to become bigger and bigger, not only in formal proposals, such as Action 1 or the EU digital services tax (DST), but also through the trend toward the taxation of Big Tech, one that is already noticeable in the State Aid ruling on Apple in Ireland1 or perhaps the tax raids on Google in France.2

Notwithstanding the various unilateral initiatives, there is an international attempt to reach a solution grounded in consensus. The approach currently most popular holds that “significant economic presence” is a taxable nexus, a revisioning that has been introduced among other “solutions” in Action 1 of BEPS. The concept of significant economic presence is a completely new approach to defining taxable nexus.

The initiatives that seem to stand out most at this time are the proposals for an EU digital services tax and the significant digital presence directive, also known as “virtual PE.”

Interestingly, the United States has been one of the first jurisdictions, if not the first jurisdiction, to apply this economic nexus approach in practice, following the U.S. Supreme Court ruling in South Dakota v. Wayfair.

Although we currently see various local and supranational initiatives that are based on some sort of economic presence (which itself is based on a certain revenue threshold), the vast majority of these initiatives have not yet been formalized. Nevertheless, it is important to realize that a number of jurisdictions are taking matters into their own hands, especially now that the EU’s DST has been put on hold.3 Some countries therefore have moved faster with their own unilateral initiatives, including, for instance, the Italian web tax, the Spanish digital services tax, and the UK digital services tax. We find this development to be cause for concern. An EU approach, if not a global one, is preferable to a collection of unilateral approaches any day of the week.

The initiatives that seem to stand out most at this time are the proposals for an EU digital services tax and the significant digital presence directive, also known as “virtual PE.”

To some extent these two EU proposals correlate, in that the DST is intended as a short-term solution to be succeeded eventually by a taxable virtual PE. Not surprisingly, the virtual PE solution entails amending the concept of PE, which requires consensus not only in Europe but also globally, to be reflected in double tax agreements. The DST, according to the European Commission, does not require updates to double tax agreements and therefore can be implemented before global consensus is reached. The reason is that the EC regards the DST as an indirect tax, and taxation rights are therefore not limited by any double tax agreement. For now, characterizing the DST as an indirect tax remains doubtful. Furthermore, one could question whether EU law, including the EU VAT directive, provides for the possibility of levying another indirect tax.

The DST and virtual PE both require unanimous consent at the EU level by all member states. As mentioned, for now it seems unlikely that this consent will be reached in the near future. Ireland and Sweden have given clear indications that they are not in favor of the EU DST and virtual PE; furthermore, France and Germany recently presented revised plans for the EU’s proposed digital tax reforms under which Big Tech would pay a levy only on advertising sales and not on total revenues, representing a significant reduction of the Commission’s original scope.

We therefore do not expect the EU DST to be introduced, if ever, prior to 2022.

Johan Visser and Gerbrand Hidding are in the global indirect tax and international corporate tax service line of Atlas Tax Lawyers, the member firm of WTS Global in the Netherlands.


  1. “State Aid: Ireland Gave Illegal Tax Benefits to Apple Worth Up to €13 Billion,” European Commission, August 30, 2016,
  2. “Google Offices Raided in Paris as Prosecutors Announce Fraud Probe,” Guardian, May 24, 2016,
  3. Alex Hunter, “France, Germany Propose New Digital Tax Plan,” TP News, December 4, 2018,

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