tax notes international - Tuck School of Business - Dartmouth College

Home State
Host State
Figure 5. Authorized OECD Approach to Agency PEs
Agent P&L
Gross income 200
Cost of services (150)
Profit 50
agency PE. 64 Considering, for example, the situation
when the credit risk on accounts receivable is not
borne by the dependent agent itself but directly by the
principal, a reward for such risk will have to be attributed
to the agency PE. 65
One major aspect of the authorized OECD approach
is that it leads to the treatment of the dependent
agent and the agency PE as two different taxable
entities. This means that the agency PE is not the dependent
agent per se; its hypothetical existence is apart
from the dependent agent and is derived because the
general enterprise in the home state has a dependent
agent in the host state. As a consequence, the authorized
OECD approach challenges the widespread idea
that the profit of an agency PE is zero by definition.
Under the authorized OECD approach, it is not
only the income earned by the dependent agent itself
that matters but also the income the general enterprise
earns through its agency PE in the host country. Whatever
is paid to the dependent agent (for example, salary,
fixed amount, or percentage of sales) should be
considered as an expense in ascertaining the agency PE
profits.
This is precisely when the authorized OECD approach
differs from the single taxpayer approach. The
payment of the dependent agent remuneration and its
deduction on the computation of the agency PE profits
does not mean that there will be no profits left. Those
profits will be determined on the basis of the functions
performed by the agency PE.
In this context, it is possible that no profit be attributable
to the agency PE depending on the functions
performed by that PE. 66 Indeed, under the OECD report,
there is no presumption that the agency PE will
always generate profits, as it may well happen that little
or no profit is attributed to it if only routine functions
General Enterprise
Permanent Establishment
Agent
are performed. Nothing prevents the general enterprise
from organizing its business in the host state in a manner
in which little or no functions are performed by the
agency PE and, as a consequence, little or no tax must
be attributable to it under the authorized OECD approach.
The authorized OECD approach determines that the
dependent agent be rewarded for the service provided
to the nonresident enterprise on an arm’s-length basis;
that is, taking into account its assets and risks, while
the profits of the agency PE should be determined on
the basis of the assets and risks of the nonresident enterprise
in relation to the functions performed by the
dependent agent on behalf of the enterprise, added by
sufficient capital to support those assets and risks. 67
By definition, the overall taxable income of the dependent
agent plus the income of the agency PE
(deemed to be independent) must be equal to the taxable
income a company would earn in an arm’s-length
transaction. In a simplistic fashion, the authorized
OECD approach can be described on the basis of the
example illustrated in Figure 5. 68
Under the authorized OECD approach, there is a
profit attributable to the agency PE in excess of the
64 Pijl, supra note 9, at 30-31.
65 Raffaele Russo, ‘‘Application of Arm’s Length Principle to
Intra-Company Dealings: Back to the Origins,’’ Int’l Transfer Pricing
J. (Jan./Feb. 2005), p. 14.
66 Pijl, supra note 9, at 32.
67 Bennett and Russo, supra note 58, at 282.
SPECIAL REPORTS
GE P&L
Gross income 2,000
Cost of goods (500)
Agent fee (200)
Profit 1,300
PE P&L
Gross income 2,000
Cost of goods (1,000)
Agent fee (200)
Profit 800
68 This example was drafted based on a similar diagram provided
by Hans Pijl in ‘‘The Zero-Sum Game, the Emperor’s
Beard and the Authorized OECD Approach,’’ supra note 9, at
32.
TAX NOTES INTERNATIONAL FEBRUARY 2, 2009 • 433
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