Anti-fragmentation Rules

Anti-fragmentation rules, also known as anti-avoidance or anti-abuse rules, are provisions included in double taxation conventions to prevent taxpayers from artificially splitting their business activities to avoid having a permanent establishment (PE) in a particular jurisdiction.

Under the Organisation for Economic Cooperation and Development Model Tax Convention, the concept of permanent establishment is crucial for determining the taxing rights of a country over business profits. A permanent establishment refers to a fixed place of business through which an enterprise carries out its business activities. It can include various forms, such as a branch, office, factory, workshop, or agency.

However, some taxpayers may attempt to fragment their business activities across different entities or locations in order to avoid creating a permanent establishment in a country where they would otherwise have a significant presence. By avoiding a permanent establishment, they seek to minimise or eliminate their tax obligations in that jurisdiction.

To counter such practices, anti-fragmentation rules have been incorporated into double taxation conventions. These rules aim to attribute the activities and profits of related entities or parts of an enterprise together, treating them as a single integrated business operation. This prevents taxpayers from circumventing the creation of a permanent establishment by artificially dividing their operations.

Anti-fragmentation rules typically allow tax authorities to disregard the legal separation of entities or the contractual arrangements between them when determining the existence of a permanent establishment. Instead, they consider the substance and economic reality of the business operations. If it is determined that the separate entities or arrangements are essentially part of a cohesive business operation, the tax authorities may treat them as a single entity for tax purposes.

By implementing anti-fragmentation rules, double taxation conventions aim to ensure that taxpayers cannot exploit artificial structures or arrangements to avoid their tax obligations in a jurisdiction. These rules help maintain the integrity of the permanent establishment concept and prevent abuse of tax treaties for improper tax planning purposes.