How a ‘shapie’ exposes the permanent establishment (PE) problem

In my last post I wrote about how any system that’s based on rules brings uncertainty – and that’s certainly true of the international tax system.

Digital business adds a new dimension to the way companies operate – and international tax law, designed for the industrial age, could be argued to be no longer fit for purpose in the digital age.

One of the basic premises of international tax law is that profits are allocated to the territory in which they are earned. If a company in Spain sells to customers in France, but has no activities in France itself, the profits are taxed in Spain. If, though, the company has sufficient presence in France to have a ‘permanent establishment’ (PE) there, some of its profit will be allocated to France, where it will be taxed.

The PE concept is a classic example of a tax rule that was devised for the industrial world and which struggles to cope with digital business. It’s already under review as part of the BEPS programme for this very reason.

Let’s take an example that I came across in the Manchester Evening News. A shop in the centre of Manchester has installed a hi-tech scanner which allows shoppers to create a 3D ‘selfie’ image – the paper called them ‘shapies’ – of themselves. A scanner, created by a Luxembourg-based business, creates a 3D image. This is sent to the company in Luxembourg, which creates a ‘blueprint’ which is sent back to the store and printed using the 3D printer as an 8-inch statue. Apparently, there’s a demand for this sort of thing.

How on earth does the international tax man unravel that? If we start with the PE question, you could be reasonably sure that if the Luxembourg business had its own UK employees operating the scanner in Manchester, a PE has been established. But in this case, the store’s employees operate the scanner and that makes it wide open to interpretation. Assuming the scanning is a key part of the process of creating a shapie, we could have endless arguments about whether a PE is created or not.

And then there’s withholding tax. Assuming the store owns the 3D printer, the payment that it makes to the Luxembourg business for the blueprint could, arguably, be seen as a royalty payment that’s subject to withholding tax (with the emphasis on ‘arguably’). And whether you agree with that or not will probably depend on whether the blueprint allows the store to print just one copy, or many.

This single example could keep us arguing for weeks. It’s all about interpretation of rules, and if the rules are hard to apply in practice, why should we be surprised if there is a disagreement between taxpayers and tax authorities?

John Steveni | Communications Tax Leader
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