The objective is to bring commissionaire arrangements within the framework of dependent agency PE. Companies are converting commissionaire to LRD. Once a commercial and tax-efficient structure is determined— one that addresses both historical and potential risk - it is time to take the theory behind the structure into the realm of practice.
BEPS and Tax
Action 7 – prevent the artificial avoidance of PE status
The final BEPS report includes changes to the definition of PE for income taxes of Article 5 of the OECD Model Tax Convention. Action 7 broadens the threshold to determine when such PE status exists.
Currently such a PE status does not exist for commissionaire arrangements and the specific activity exemptions in treaties, such as warehousing, purchasing and “preparatory and auxiliary activities.
The indirect tax definition of a fixed establishment (FE) is different from a PE and has its foundation in EU VAT law and should therefore not be affected by the BEPS initiative or OECD definition. Some countries however do (still) not accept the absence of a FE once a PE has been established.
Note that the amount of PEs will increase when "Action 7" is in force (e.g., commissionaire, overseas warehouses, toll manufacturing, marketing agents, consignment stock). For example this risk of PE increases when an agent is actively involved in generating sales locally and that activity directly results in a binding contract.
The objective is to bring commissionaire arrangements within the framework of dependent agency PE
Moving away from commissionaire structure
As businesses are facing global challenges it makes sense that the existing business model is reevaluated and amended when necessary to meet the new PE environment. A less risky model is the limited risk distributor (LRD).
That most likely means moving away from a commissionaire structure. Principal company sells to a master sales company (e.g., in the same country as the principal company) under a LRD agreement, and the master sales company resells through its local branches.
Tax planning is benefited when the business model has as outcome that the profit drivers such as the 'value added functions' and 'risk', are assigned to a low-tax jurisdiction. That means at the level of the Principal the central coordination, strategy and planning should take place:
- Sales & Marketing strategy
- Strategic sourcing
- Business planning
- Brand management
- Supply / Demand planning
- Capacity planning
- Inventory deployment
- Order processing and management
- Lean Manufacturing principles
- Ownership of intangibles
- Key risks
Note that the tax authorities will therefore have, as profit is allocated to low-tax jurisdictions, an extra interest in auditing the conversion. I refer for more details to the chapter 'Tax Audit Defense'.
Adapt to change in time
Determine impact of such changes of the company's supply chain and/or location of its tax functions. This could result in new set-up of ERP system and invoicing, new contracts, pricing procedures, processes and controls. Critical success factors are:
- Senior management support for change: 'Tax model should be based on business case and not vice versa'
- Existence of a solid and compelling integrated business case for the structure
- Sound, structured and proven design and implementation process driven by rigorous Project Management
- Complete understanding of the facts, objectives, transaction flows, business process and legal structure
- Early focus on integration with IT systems and operations
- Early buy-in to the “transformation” by management and those groups affected ('Change Management')
- Allocation of adequate resources by the company to manage and implement the project
Converting the sales middleman function from Commissionaire to LRD
Start point from an ERP perspective is to investigate how the commissionaire is set-up from a current operational state.
Below 2 different ways how a commissionaire could have been implemented in SAP:
- Revenue of the commissionaire is directly booked by the principal. The principal has set-up all master data. Manual corrections were made for VAT reporting. VAT is in that set-up a real botteneck and the root cause is that for VAT purposes a commissionaire is deemed to be a buy/sell. VAT treatment for Commissionaires and LRDs in principle similar (buy and sell), but with different legal flows. That VAT qualification is however in conflict with the legal reality as the commissionaire sells in its own name but on behalf the principal; legal title of the goods transfers directly from Principal to the customer. This VAT bottleneck often results that lots of manual corrections have to be made to facilitate correct VAT reporting
- Commissionaire is set up as a buy-sell and the master data of the commissionaire is used. VAT correct, but legally - as mentioned above - wrong as the revenue belongs to the Principal and the commissionaire receives a commission from the principal.
When option 1 has been implemented and the commissionaire model will now be converted to a LRD, the consequence is that the master data has to be transferred from the Principal to the local LRD and thus the VAT determination logic for the LRD's business transactions has to be designed and properly tested before the LRD can become fully operational. I refer to chapter 'SAP implementation' that describes the process.
As a LRD has revenue in its books, option 2 above might make conversion to a LRD a bit easier as in a business transaction the Principal to LRD and LRD to Customer will transfer legal title.
Below the relevant work streams and an example each to consider:
- Corporate Income Tax - e.g. assess impact local direct taxes
- Transfer Pricing - e.g. amend current TP documentation to reflect change of CMRs to LRDs
- VAT - e.g. different accounting rules for LRDs compared to Commissionaires may significantly impact current SAP logic
- Customs - e.g. need to investigate impact of adjusted transfer prices to Customs valuation
- Legal - e.g terminate commissionaire agreement
- Technology - e.g. implement LRD in SAP and be aware that full VAT AP and AR automation for also the most complex transactions, real time access to numbers / blueprint of business model (integrated in SAP: data analytics) and automated VAT controls are all possible
More detail in 'Manage business model change'
Not only finance but also tax needs access to data that shows how transactions are processed and how IT systems are set up. Data integrity is an operational risk factor when transactions are booked in any given country and are not properly evaluated for tax purposes.
It could be that the financial data in the system does not reflect the business model design or that change is not properly managed.
The inherent risk is in practice often that what has initially designed and contractually agreed is not in line (anymore) with the (current) factual reality. The financial data could disclose what is really occurring from a business model perspective. For example, more local risks could for example exist due to (new) services, supply of goods, sales support, amount of employees and their skill set / roles.
Besides that in the 'as is' it is often a challenge to get access to the relevant tax data that must be reported to regulators, investors and tax authorities in every business unit and country in which a company operates.
KGT SAP add-ons for SAF-T, e-invoicing and MTD UK for VAT work as a standalone application within the SAP system and does not change existing customer SAP functionality or processes. It is fully configurable with custom namespace /KGT.
KGT partnered up with SAP regarding 'SAP Advanced Compliance Reporting for SAP HANA'. The 'Advanced Compliance Reporting' (ACR) service enables you to configure, generate, analyze, and electronically submit statutory reports that contain indirect taxes, such as value-added tax.
KGT provides also S/4 HANA transformation support.