tax notes international - Tuck School of Business - Dartmouth College
tax notes international - Tuck School of Business - Dartmouth College
tax notes international - Tuck School of Business - Dartmouth College
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commentary to be used in the negotiation <strong>of</strong> future<br />
treaties and <strong>of</strong> amendments to existing treaties. Thus,<br />
the OECD Committee on Fiscal Affairs recently released<br />
as a discussion draft what it called the second<br />
part <strong>of</strong> the implementation package — a new version<br />
<strong>of</strong> article 7 and related commentary changes. The committee<br />
will be receiving comments on this discussion<br />
draft until December 31, 2008, and it is expected that<br />
the new article and the commentary changes will be<br />
included in the next update to the OECD model <strong>tax</strong><br />
convention, which is tentatively scheduled for 2010. 56<br />
Considering that this article is focused on case law<br />
on the attribution <strong>of</strong> pr<strong>of</strong>its to agency PEs, and the<br />
decisions were held before the release <strong>of</strong> the discussion<br />
draft <strong>of</strong> the new version <strong>of</strong> article 7 and related commentary<br />
changes, all comments made refer to the current<br />
wording <strong>of</strong> the OECD model convention and the<br />
‘‘Report on the Attribution <strong>of</strong> Pr<strong>of</strong>its to Permanent<br />
Establishments.’’ One first important issue that arises is<br />
what weight should be given to this report in applying<br />
<strong>tax</strong> treaties currently in force. The specialized doctrine<br />
has already discussed at length the legal status <strong>of</strong> the<br />
commentary to the OECD model convention, and it<br />
can be said that there is no generally accepted view on<br />
this controversial issue. 57 If the legal status <strong>of</strong> the commentary<br />
is unclear and subject to a variety <strong>of</strong> different<br />
interpretations, more obscure is the role <strong>of</strong> a report<br />
that was, at the time the decisions being analyzed were<br />
held, not implemented yet.<br />
The OECD recognizes in paragraph 7 <strong>of</strong> the revised<br />
commentary on article 7 that there are differences between<br />
some <strong>of</strong> the conclusions <strong>of</strong> the report and the<br />
interpretation <strong>of</strong> article 7 previously given in the commentary<br />
in a way that the report should only provide<br />
guidelines for the application <strong>of</strong> the arm’s-length principle<br />
incorporated in the article to the extent that it<br />
does not conflict with the commentary. In case <strong>of</strong> conflict<br />
between the two, the commentary should always<br />
prevail over the report. 58<br />
This is not mere academic debate; rather, it is a very<br />
important issue in practice as the conclusions <strong>of</strong> the<br />
report lead to major consequences on the attribution <strong>of</strong><br />
pr<strong>of</strong>its to PEs in general and particularly to agency<br />
PEs. The Indian Income Tax Appellate Tribunal had to<br />
56 See id.<br />
57 See, e.g., Vogel, supra note 3, at 43; David A. Ward, ‘‘The<br />
Role <strong>of</strong> the Commentaries on the OECD Model in the Tax<br />
Treaty Interpretation Process,’’ Bulletin — Tax Treaty Monitor<br />
(Mar. 2006), p. 98; and John F. Avery Jones, ‘‘The Effect <strong>of</strong><br />
Changes in the OECD Commentaries After a Treaty Is Concluded,’’<br />
Bulletin — Tax Treaty Monitor (Mar. 2002), pp. 102-109.<br />
58 Mary Bennett and Raffaele Russo, ‘‘OECD Project on Attribution<br />
<strong>of</strong> Pr<strong>of</strong>its to Permanent Establishments: An Update,’’<br />
Int’l Transfer Pricing J. (Sept./Oct. 2007), p. 283.<br />
SPECIAL REPORTS<br />
face this dilemma in the SET Satellite case; the <strong>tax</strong>payer<br />
referred to the report as ‘‘what the law should be and<br />
not what the law is.’’ 59<br />
To address the different interpretations, I will first<br />
present a summary <strong>of</strong> the authorized OECD approach<br />
to attribute pr<strong>of</strong>its to PEs in general, followed by an<br />
analysis <strong>of</strong> its specific features regarding agency PEs,<br />
and finally the particularities <strong>of</strong> the single <strong>tax</strong>payer approach.<br />
C. The Authorized OECD Approach<br />
Between the two main interpretations <strong>of</strong> the provisions<br />
<strong>of</strong> article 7 <strong>of</strong> the OECD model convention regarding<br />
the attribution <strong>of</strong> pr<strong>of</strong>its to PEs, the OECD<br />
opted for the functionally separate entity approach,<br />
rather than the relevant business activity approach.<br />
Now one can see that the reason why the first is also<br />
called the authorized OECD approach is because it<br />
provides for the OECD preferred interpretation <strong>of</strong> article<br />
7. 60<br />
The authorized OECD approach provides that the<br />
pr<strong>of</strong>its to be attributed to a PE must be the pr<strong>of</strong>its that<br />
it ‘‘would have earned at arm’s length if it were a legally<br />
distinct and separate enterprise performing the<br />
same or similar functions under the same or similar<br />
conditions.’’ 61 Conversely, the functionally separate entity<br />
approach does not limit the pr<strong>of</strong>its <strong>of</strong> the PE by<br />
reference to the pr<strong>of</strong>its <strong>of</strong> the enterprise as a whole. As<br />
a consequence, it is perfectly possible under this approach<br />
to attribute pr<strong>of</strong>its to a PE even if the enterprise,<br />
considered as whole, incurs a loss.<br />
The OECD report reaffirms the primacy <strong>of</strong> the<br />
arm’s-length principle in attributing pr<strong>of</strong>its to PEs by<br />
determining the adoption <strong>of</strong> the functionally separate<br />
entity approach. As shown below, the application <strong>of</strong><br />
this approach requires a stretch: The PE is supposed to<br />
be treated as a functionally separate entity <strong>of</strong> its head<br />
<strong>of</strong>fice, though it is part <strong>of</strong> the same enterprise. Once<br />
the PE cannot enter into actual transactions with other<br />
parts <strong>of</strong> the enterprise <strong>of</strong> which it is part, it is necessary<br />
to provide for the recognition <strong>of</strong> the dealings between<br />
the PE and its head <strong>of</strong>fice, which goes against<br />
the axiom that an enterprise cannot make a pr<strong>of</strong>it from<br />
dealing with itself.<br />
1. The Authorized OECD Approach to PEs<br />
The application <strong>of</strong> the functionally separate entity<br />
approach under the report requires a two-step analysis:<br />
• the functional and factual analysis; and<br />
• the comparability analysis.<br />
59<br />
Indian Income Tax Appellate Tribunal, Apr. 20, 2007, decision<br />
535/Mum/04 and 205/Mum/04.<br />
60<br />
Para. 78 <strong>of</strong> the ‘‘Report on the Attribution <strong>of</strong> Pr<strong>of</strong>its to Permanent<br />
Establishments,’’ Part I (General Considerations), (2006).<br />
61<br />
Id. at para. 10.<br />
TAX NOTES INTERNATIONAL FEBRUARY 2, 2009 • 431<br />
(C) Tax Analysts 2009. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content.