Does the Substance over Form approach implemented as a result of the BEPS package reconciles the Permanent Establishment definition with the existence of economic allegiances?

Abstract: The Permanent Establishment (PE) concept plays a key role in the distribution of taxing rights between States by determining when the profits derived by an entity are taxable in a State other than the State of its residency. This concept, originally, evidenced the existence of sufficient economic allegiances between a non-resident entity and a State to justify taxation therein. However, the evolution of business models caused situations where a non-resident entity is substantially involved in the economy of a State without triggering a PE. Hence, a divergence between the existence of economic allegiances and the PE definition was created. In order to tackle the circumvention of the PE definition, the Base Erosion and Profit Shifting (BEPS) package of the Organization of Economic Co-operation and Development (OECD) introduced several changes to the PE rules established in their 2014 Model Tax Convention on Income and on Capital (MTC). These changes mainly follow a Substance Over Form (SOF) approach which overlooks the legal qualifications a business model to focus in its economic activities and the value created. In principle, this could reconcile the PE definition with the existence of significant economic allegiances. Closely analysing each change to the PE definition, they do reconciliate these concepts in some scenarios but fail to do so in several others. Particularly these changes mostly fail to reconcile them in the case of digital business models. Moreover, some changes presume the existence of a PE when the non-resident entity may not be substantially involved in the State, thus broadening the divergence. Based on the above, these changes fail to fully reconcile the existence of significant economic allegiances with the PE definition, which translates in a failure to properly distribute taxing rights between States. Furthermore, the SOF approach introduced by the BEPS package brings legal uncertainty for foreign investments which means it loses one of the reasons for its historical success.