OECD provides additional guidance on the attribution of profits to permanent establishments
Action 7 in the OECD’s Base Erosion and Profit Shifting (BEPS) project addressed the artificial avoidance of permanent establishment (PE) status through three practices:
- Commissionaire arrangements in which the commissionaire played the principal role leading to the conclusion of contracts without actually concluding the contracts (Article 5(5) of the OECD Model Tax Convention (MTC))
- The fragmentation of activities such that the activities, considered separately, would be treated as preparatory or auxiliary instead of complementary and part of a cohesive business operation (Article 5(4))
- Splitting between different entities within the same group in the time period during which the contracts would be performed so that no single entity appeared to perform the contract for longer than 12 months (Article 5(3))
The OECD subsequently modified the MTC to address each of those practices.
Action 7 concluded by promising additional guidance on the attribution of profits to PEs under the revisions to Articles 5(5), 5(4) and 5(3). The OECD’s Committee on Fiscal Affairs issued two public discussion drafts, one in July 2016, the other in June 2017, inviting comments on the application of Article 7 of the MTC to the new rules, and in particular, Article 7’s treatment of PEs as separate and independent for purposes of determining their business profits.
The OECD’s recent Additional Guidance on the Attribution of Profits to Permanent Establishments – BEPS Action 7 Report (March 2018)
(Additional Guidance) is the result of that process. The Additional Guidance provides “high-level general principles” regarding the application of Article 7 to the revised PE rules.
The Additional Guidance includes four examples. One example relates to preparatory and auxiliary activities, another to commissionaire arrangements, a third to sales of advertising on a website and a fourth to procurement of goods by an intermediary. The fact patterns in each example are followed by detailed applications of the Authorized OECD Approach (AOA) to determining the profits attributable to PEs. That application involves two general steps. The first is a factual and functional analysis to determine the functions, risks and assets that should be attributed to the PE, with a view to characterizing the nature of the “internal dealing” (that is, the intercompany transaction) between the PE and the enterprise, generally. The second step requires application of the OECD’s Transfer Pricing Guidelines to the facts in step one to determine the appropriate amount of profits allocable to the PE.
The approach set out in the Additional Guidance has limitations. First, the revisions to Article 5 set out in the MTC have not been universally adopted and applied. Second, many tax treaties do not prescribe use of the AOA. The OECD acknowledges in the Additional Guidance that the examples are illustrative only and should not be interpreted as prescribing specific arm’s-length arrangements in actual cases. Despite these limitations, taxpayers would be well advised to consider potential application of the analytical framework set out in the Additional Guidance to their planning and controversy matters.
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