The final guidance covers how the attribution of profits to PEs should take account of BEPS changes to the PE definition and the transfer pricing guidelines.
The OECD issued final guidance on 22 March 2018 on how the attribution of profits to permanent establishments (PEs) under Article 7 of the Model Tax Convention should take account of the changes in the final BEPS reports to both the PE definition and the transfer pricing guidelines (TPG). The guidance is focused on situations where a PE now arises under the BEPS changes to the Article 5 definition. It includes three examples relating to dependent agent PEs (DAPEs) and one example relating to a warehouse and an office. The OECD published discussion drafts in 2016 and 2017 and held a public consultation in November 2017. While the analysis of the examples has been expanded, and is now closely aligned to the Authorised OECD Approach (AOA) to the attribution of profits, there are otherwise few changes as a result of the consultation.
This is balanced by explicit recognition that the guidance is not intended to extend the AOA to those countries that do not currently apply the AOA in their treaties or domestic legislation.
In each example, the PE earns the profit (or loss) it would have earned as a separate enterprise dealing at arm’s length with the rest of the enterprise of which it is a part.
In example 1, a non-resident company owns a warehouse and an office in the host country. They provide complementary functions that are part of a cohesive business operation, thereby creating two PEs. Economic ownership of the warehouse and office are attributed to the PEs. Two dealings are hypothesized between the head office and the two PEs: one for storage and delivery services provided by the warehouse PE, and a second for merchandising and information collection by the office PE. The reward for both dealings is determined under the TPG, under Step 2 of the AOA.
The example attributes economic ownership of the warehouse and the office to the PEs based on the functional analysis, which is stated to demonstrate that the Significant People Functions (SPFs) relevant to their management are performed by personnel of the PE in the host country. The AOA actually attributes tangible fixed assets according to their place of use, rather than using SPFs. As the example is explicitly analysed under the AOA, the reference to SPFs here may be an oversight.
Example 2 describes a commissionaire arrangement. The commissionaire sells widgets and performs marketing functions on behalf of a non-resident company in return for an arm’s length commission. The SPFs in respect of inventory are performed by the personnel of the commissionaire on behalf of the non-resident enterprise; the economic owner of the inventory is therefore the DAPE.
Many commentators argued, under the latest TPG, that the risk and reward associated with the inventory should be attributed to the entity with the people controlling that risk, as part of the arm’s length reward to the commissionaire. There would then be no assets or risk in the DAPE and therefore no profits to tax in the DAPE.
Example 3 describes the sale of advertising on a website on behalf of a related company, while example 4 describes the procurement of goods by a related intermediary. The analysis closely follows example 2 in each case, and risks are attributed to the DAPE.
Commentators proposed a number of changes which have not been made:
Overall, the final guidance provides more certainty that applying existing methods remains appropriate for all PEs where the AOA applies, but wide variations will continue to arise in practice based on domestic law, treaties or tax authority positions.
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