2.4.2.2 Closely related enterprise

The concept of closely related enterprise is relevant to the permanent establishment definition as included in the OECD MTC.1 The concept is relevant for determining whether or not there is a permanent establishment in the source state, which gives the source state taxing rights in respect of business profits.2 By introducing the concept of closely related enterprise, the OECD aims to prevent the artificial avoidance of the qualification of a permanent establishment. The concept therefore plays a role in various new permanent establishment elements. To assess whether a permanent establishment exists, the activities of a closely related enterprise should also be taken into account from now on.3 This applies to the determination of whether activities should be considered ancillary or preparatory activities. The introduction of the concept of closely related enterprise is important for the independent agent provision as well.4 Furthermore, the concept is relevant to the MLI provision on preventing the splitting-up of contracts.5

The definition of a closely related enterprise reads as follows:6

The first part of the provision gives a general interpretation of the concept. According to this definition, a person or enterprise is closely related to an enterprise if – based on all relevant facts and circumstances – the enterprise has control over the other. An example is the relationship between a parent company and a subsidiary company. In addition, there is a closely related enterprise if – also based on all relevant facts and circumstances – both persons or enterprises are controlled by the same persons or enterprises. This can be the case, for example, with two sister companies. This general rule applies, for example, if a person or enterprise controls an enterprise on the basis of a special agreement which ensures that rights may be exercised which are similar to those it would have if it held, directly or indirectly, more than 50% of the beneficial interest in the other person or enterprise.7

The second part of art. 5, par. 8, OECD MTC indicates that under certain conditions a close relationship automatically exists. The close relationship is assumed to exist if an enterprise directly or indirectly holds more than 50% of the beneficial interest in the other, or if one person or enterprise directly or indirectly holds more than 50% of the beneficial interest in the person and enterprise or the two enterprises. If there is a company, the total number of votes and the value of the shares of the company or of the beneficial equity interest in the company is considered.

Art. 5, par. 8, OECD MTC uses two terms: person and enterprise. The concept of person includes an ‘individual, a company and any other body of persons’.8 The provision therefore covers relationships with natural persons, legal entities and unincorporated legal forms. The OECD defines the concept of enterprise as ‘the carrying on of any business’.9 Whether an activity is carried on within an enterprise, or constitutes an enterprise itself, is to be interpreted according to national law.10 The term refers to the business activity itself and not to the person carrying it on. It is therefore irrelevant whether or not the business activities are carried on within a legal form.11

The scope of the concept of a closely related enterprise seems to be clear: one enterprise controls the other, or both enterprises are under common control. The scope takes a substantive approach, while introducing a clear definition. This dual approach offers both the possibility of countering abuse (i.e., deliberately ensuring that the conditions are not met) and a certain form of legal certainty. After all, there will always be an associated enterprise for companies that meet the 50% requirement. Abuse is prevented because in situations where the 50% requirement is not met, there can still be a closely related enterprise. The fact that, in principle, the facts and circumstances of the case must be examined in order to determine whether or not there is a closely related enterprise can obviously lead to much uncertainty. The question is, for example, how this principle should be applied in the case of joint ventures with disproportionate ownership of vote and value.12 In principle, this is for tax authorities to decide.