REPORT ON THE ATTRIBUTION OF PROFITS TO …

1 ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT. REPORT ON THE ATTRIBUTION OF PROFITS TO permanent ESTABLISHMENTS. PARTS I (GENERAL CONSIDERATIONS), II (BANKS) AND. III (GLOBAL TRADING). DECEMBER 2006. CENTRE FOR TAX POLICY AND ADMINISTRATION. ATTRIBUTION OF PROFITS TO permanent ESTABLISHMENTS: UPDATE ON STATUS AND RELEASE OF NEW VERSIONS OF PARTS I, II AND III. 1. As previously acknowledged by the OECD and confirmed by a recent study by the International Fiscal Association,1 the practices of OECD and non-OECD countries regarding the ATTRIBUTION of PROFITS to permanent establishments and these countries' interpretation of Article 7 (Business PROFITS ) of the OECD. Model Tax Convention vary considerably.

2 This lack of a common interpretation and consistent application of Article 7 can lead to double taxation and non-taxation situations. 2. In order to achieve a greater consensus in this area, the OECD decided to examine how the principles developed in the 1995 OECD Transfer Pricing Guidelines, which address the application of the arm's length principle to transactions between associated enterprises under Article 9 (Associated Enterprises), should apply in the context of the relationship between a permanent establishment and the rest of the enterprise to which it belongs. As a first step, a working hypothesis was developed as to the preferred approach for attributing PROFITS to a permanent establishment under Article 7.

3 Whilst the development of the working hypothesis was based on the wording of the provisions of Article 7, it was not constrained by either the original intent or by the historical practice and interpretation of the Article and the interpretations reflected in the Commentary. Rather the intention was to formulate the preferred approach to attributing PROFITS to a permanent establishment under Article 7 given modern-day multinational business models and practices. At the outset of this work it was agreed that there should be consultation with business and non-OECD countries. Input from these groups has been extremely helpful in revising the original proposals. 3. The working hypothesis was further analysed by considering how it could be applied in practice to attribute PROFITS both to permanent establishments in general and, in particular, to permanent establishments of businesses operating in the financial sector, where trading through a permanent establishment is widespread.

4 Discussion drafts containing the interim results of analysing the application of the working hypothesis to permanent establishments in general (Part I) and to permanent establishments of banking enterprises (Part II) were released in February 2001. Following extensive consultation, a revised version of Part II and a new Part III dealing with permanent establishments of enterprises engaged in global trading were released for public comment in March 2003. A revised version of Part I was subsequently released for public comment in August 2004, and revised versions of Parts II and III were released to previous commentators at the same time. Part IV, which deals with the application of the working hypothesis to permanent establishments of insurance enterprises, was released as a discussion draft in June 2005.

5 4. In January 2005, the Committee on Fiscal Affairs mandated a working group to examine how the conclusions reflected in the final version of Parts I to IV (when completed) could be incorporated in the OECD Model Tax Convention and/or the Transfer Pricing Guidelines. The working group was asked, in particular, to analyse whether these conclusions should be reflected in the Commentary and whether changes might need to be made to Article 7. 1 The ATTRIBUTION of PROFITS to permanent Establishments, Cahiers de droit fiscal international, vol. 91b, Sdu Fiscale & Financi le Uitgevers, the Netherlands, 2006. 2. 5. At its last meeting, in June 2006, the Committee examined the progress achieved on the revision of Parts I to III as well as on the above implementation issues.

6 It noted with satisfaction that a new version of Parts I to III, which maintains the broad elements of the previously published drafts, was substantially completed. The Committee decided that the new version of these parts should be released before the end of 2006. Based on the public consultation held on Part IV in March 2006, it was clear, however, that that last part needed more work and that a new version should be published as soon as possible after the publication of Parts I to III. 6. In accordance with these decisions, the Committee is now releasing new versions of Part I. (General Considerations), Part II (Banking) and Part III (Global Trading). These new versions replace all previous drafts of these three Parts, which should no longer be considered to reflect the views of the Committee.

7 The Committee has instructed the implementation work to proceed on the basis of these new versions. A round of public consultation on the implementation package will take place once that package is available. The implementation package will then proceed through the normal OECD process of finalisation of changes that are included in the regular updates of the OECD Model Convention, with the possibility that member countries may introduce reservations or observations at that stage. 7. As stated, the existing Article 7 was the starting point for this project. There is a broad consensus among OECD member countries that the conclusions reflected in the new versions of Parts I to III. represent a better approach to attributing PROFITS to permanent establishments than has previously been available, while recognising that there are differences between some of these conclusions and the existing practices and historical interpretation of current Article 7.

8 The Committee's central aim in this work has been to reduce the risk of double taxation, a risk which escalates in the absence of a consensus. It is expected that the course now proposed will promote consistency of approach among member countries when considering application of those conclusions and will thus reduce the risk of double taxation. 8. The current Commentary on Article 7, which includes a number of changes made in 1994, prescribes specific approaches in some areas and leaves considerable leeway in others. As noted, there is a broad consensus among OECD member countries that the conclusions reflected in Parts I to III constitute the preferred approach to attributing PROFITS to permanent establishments.

9 That said, the decision as to whether member countries wish to adopt those conclusions when interpreting their existing conventions, or when entering new ones, is a matter for the Contracting States. Such decisions will no doubt be taken in light of the Contracting States' understanding of their domestic and international law as it applies to the treaty they are considering. 9. From the Committee's perspective, the best way to provide tax administrations and taxpayers with maximum certainty as to how PROFITS should be attributed to permanent establishments is to redraft Article 7 in a way that will remove the potential for different interpretations based on previous practices and the existing Commentary.

10 The conclusions reflected in Parts I to III will, therefore, be reflected in a new version of the Article, and of a new Commentary on that Article, to be used in the negotiation of future treaties and of amendments to existing treaties. 10. In addition, however, the Committee considers that many of the conclusions reflected in Parts I to III do not conflict with the existing Commentary. Therefore, in order to provide improved certainty for the interpretation of existing treaties based on the current text of Article 7, the Committee has decided that revised Commentary for the current version of Article 7 should also be prepared, to take into account those conclusions reflected in Parts I to III that do not conflict with the existing Commentary.