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