After long discussions and controversies, the OECD released on 22 July of 2010 its final report focusing on formulating the most preferable approach to the attribution of profits to a permanent establishment
After long discussions and controversies, the OECD released on 22 July of 2010 its final report focusing on formulating the most preferable approach to the attribution of profits to a permanent establishment (PE). No further discussions on the definition of PE in Article 5 were addressed in this report, but taxpayers hope that it will be an effective way of reducing the risk of double taxation and the uncertainty around cross-border transactions.
However, these changes will only be effective for states that specifically adopt the new Article 7 either by updating the existing treaties or by entering into new treaties.
The 2010 report adopts the ‘separate entity’ approach by which a PE is treated as a functionally separate and independent entity for purposes of determining its business profits under the new Article 7. But would this report and new comments on Article 7 avoid future decisions based on the force of attraction principle, as seen in Linklaters LLP v ITO?
Yes, this report emphasised that the ‘functionally separate entity’ approach removes any possible application of the ‘force of attraction’ principle, setting a limit on the amount of profit that may be taxed in the host country of the PE. Therefore, it is expected that it will be considered by the Courts to avoid double taxation.
In line with the OECD new report, the UK attribution provisions are explicit that non-resident’s profits taxable in the UK should be determined under the ‘separate entity’ approach, according to the arm’s-length principle. When using the fiction of a separate entity to attribute profits to a PE, the OECD report sets up a series of steps that should be considered by the taxpayers, such as: functional and factual analysis, attribution of assets, risks and free capital.
The OECD’s approach defines the appropriate arm’s-length remuneration of the PE’s revenues. Some factual uncertainties for the application of key TP concepts will persist in the attribution of profits to a PE, such as: What is the definition of ‘significant people functions’? How to determine the correct amount of contributions for intangible assets?
As practitioners are well aware, different interpretations of the arm’s-length standard may lead to conflicting views and techniques for the identification of the adequate arm’s-length revenues. Therefore, the contracting states will need to come to an agreement regarding the methodology that results in a fair arm’s-length attribution of profits to PEs.
Debora Correa, International Tax Specialist, Temenos USA Inc
After long discussions and controversies, the OECD released on 22 July of 2010 its final report focusing on formulating the most preferable approach to the attribution of profits to a permanent establishment
After long discussions and controversies, the OECD released on 22 July of 2010 its final report focusing on formulating the most preferable approach to the attribution of profits to a permanent establishment (PE). No further discussions on the definition of PE in Article 5 were addressed in this report, but taxpayers hope that it will be an effective way of reducing the risk of double taxation and the uncertainty around cross-border transactions.
However, these changes will only be effective for states that specifically adopt the new Article 7 either by updating the existing treaties or by entering into new treaties.
The 2010 report adopts the ‘separate entity’ approach by which a PE is treated as a functionally separate and independent entity for purposes of determining its business profits under the new Article 7. But would this report and new comments on Article 7 avoid future decisions based on the force of attraction principle, as seen in Linklaters LLP v ITO?
Yes, this report emphasised that the ‘functionally separate entity’ approach removes any possible application of the ‘force of attraction’ principle, setting a limit on the amount of profit that may be taxed in the host country of the PE. Therefore, it is expected that it will be considered by the Courts to avoid double taxation.
In line with the OECD new report, the UK attribution provisions are explicit that non-resident’s profits taxable in the UK should be determined under the ‘separate entity’ approach, according to the arm’s-length principle. When using the fiction of a separate entity to attribute profits to a PE, the OECD report sets up a series of steps that should be considered by the taxpayers, such as: functional and factual analysis, attribution of assets, risks and free capital.
The OECD’s approach defines the appropriate arm’s-length remuneration of the PE’s revenues. Some factual uncertainties for the application of key TP concepts will persist in the attribution of profits to a PE, such as: What is the definition of ‘significant people functions’? How to determine the correct amount of contributions for intangible assets?
As practitioners are well aware, different interpretations of the arm’s-length standard may lead to conflicting views and techniques for the identification of the adequate arm’s-length revenues. Therefore, the contracting states will need to come to an agreement regarding the methodology that results in a fair arm’s-length attribution of profits to PEs.
Debora Correa, International Tax Specialist, Temenos USA Inc
