Discussion drafts on attribution of profits to permanent establishments and transactional profit splits published on 22 June.
On 22 June the OECD released two BEPS discussion drafts with comments requested by 15 September. The first, titled “Additional guidance on Attribution of Profits to Permanent Establishments” relates to the earlier report on Action 7 of the BEPS Action Plan. This report mandated the development of additional guidance on how the rules of Article 7 of the OECD Model Tax Convention would apply to Permanent Establishments (PEs) resulting from the changes set out within the report, in particular for PEs outside the financial sector. The second, titled “Revised Guidance on Profit Splits” relates to Action 10 of the BEPS Action Plan. This latest discussion draft includes clarification of the application of transfer pricing methods, in particular the transactional profit split method, in the context of global value chains.
Additional Guidance on Attribution of Profits to Permanent Establishments
This discussion draft replaces an earlier draft published for comments in July 2016. It sets out high-level general principles for the attribution of profits to PEs in the circumstances addressed by the Report on BEPS Action 7. It also includes examples illustrating the attribution of profits to PEs arising under Article 5(5) and from the anti-fragmentation rules in Article 5(4.1) of the OECD Model Tax Convention.
The new draft abandons the previous examples with their focus on complex calculations, on which the OECD received extensive comments. This is welcome. The high-level principles seem more in line with the 2008 and 2010 Reports on the Attribution of Profits to PEs, but the lack of detail may reflect a lack of consensus on how to apply them, leading to more double taxation and mutual agreement procedures.
One of the main comments on the previous guidance was that taxpayers were hoping to avoid filing obligations for the non-resident enterprise in the host country where PEs arose under the new BEPS definition but no profits were attributable to those PEs. The new guidance acknowledges the compliance burden this may create but leaves the matter (as before) to the host country to decide.
Revised Guidance on Profit Splits
This discussion draft also replaces an earlier draft released for public comment in July 2016. Building on the existing guidance in the OECD Transfer Pricing Guidelines, as well as comments received on the July 2016 draft, this revised draft is intended to clarify the application of the transactional profit split method, in particular, by identifying indicators for its use as the most appropriate transfer pricing method, and providing additional guidance on determining the profits to be split. The revised draft also includes a number of examples illustrating these principles.
The revised guidance builds on the earlier discussion draft and confirms that transactional profit splits are most appropriate where each enterprise makes unique and valuable contributions and the business is highly integrated. The guidance also aligns to the revisions made to Chapters I and VI of the guidelines. So transactions should be accurately delineated in deciding whether a profit split is appropriate, economically significant risks should either be shared or separately assumed by both parties, and unique intangibles should be identified in accordance with the guidance in Chapter VI. The guidance also sets out how to define the profits to be split and gives a series of examples of how it can be applied.
Given the increased focus of tax administrations on two sided methods this guidance is welcomed as it will help business to decide when and how to apply a profit split that aligns with the wider BEPS revisions to the OECD Transfer Pricing Guidelines.
It is also worth noting that unlike the attribution of profits release, this draft includes a number of specific questions for commentators on some of the fundamentals of the profit split method, and therefore seems less likely to be a substantially final draft.
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