tax notes international - Tuck School of Business - Dartmouth College

SPECIAL REPORTS
If the single taxpayer approach is adopted, these
eventual additional functions or risks of the enterprise
in the host state will never be remunerated, which is
clearly against the wording of article 7, and which is
intended to provide for tax sharing between home and
host states weighted on the basis of the functions performed,
assets used, and risks assumed.
This interpretation is shared by Richard Vann;
though he believes that the existing theories regarding
the allocation of profits to PEs are not convincing, he
expresses his preference for what he called the ‘‘rowing
or relay theory,’’ under which:
every transaction within the boundaries of the
firm is intended to produce a profit over and
above the market price of any intra-firm transaction
or dealing that operates as an input into that
profit and that profit is allocated to all parts of
the firm which participate in the realisation of
the ultimate profit on the sale to the third party. 99
The name of this theory refers to the idea that each
member of the team contributes to the overall profit as
they all work together towards the same goal, which
resembles a rowing race.
Therefore, it is clear that the authorized OECD approach
is the only method that entails an adequate allocation
of risks within the enterprise, avoiding an undue
limitation of the host state taxing rights. If the
resulting increase in host state taxation is undesirable,
this is an issue of tax policy that does not overcome
the conclusion that the authorized OECD approach
provides for a proper allocation of risks within the enterprise,
as opposed to its contrary single taxpayer approach.
B. The Rationale Behind Article 7
In my view, it is undisputable that the rationale of
the OECD report is in line with the underlying principle
codified in article 7.
Article 7 upholds primacy of the arm’s-length principle
in attributing profits to PEs as a natural consequence
of the adoption of the separate entity fiction. 100
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. In the framework of an agency PE,
the host state is therefore entitled to tax the profits that
99
Richard J. Vann, ‘‘Tax Treaties: The Secret Agent’s Secrets,’’
Brit. Tax Rev. (50th Anniversary Edition), no. 3 (2006), p.
345.
100
In 1933 the League of Nations draft already provided for
the arm’s-length principle as the guidance for the allocation of
profits to intracompany dealings; see Russo, supra note 65, at 7.
In this sense, the convention determined that a PE must be
treated in the same manner as independent enterprises operating
under the same or similar conditions.
the agency PE might be expected to make if it were a
separate enterprise engaged in the same or similar activities
under the same or similar conditions and dealing
wholly independently with the enterprise of which
it is a PE.
Some authors expressed concern about the requirement,
under the authorized OECD approach, of the
PE recognizing notional payments as a deduction or as
basis for attributing profits, based on the notion that
‘‘an enterprise cannot make a profit from dealing with
itself.’’ 101
However, by adopting the transfer pricing guidelines
to a general enterprise and PE relationship, the only
result that is harmonious is that the PE profits must be
determined in accordance with the assets and risks of
the nonresident enterprise relating to the functions performed
by the dependent agent on behalf of the nonresident
enterprise, together with sufficient capital to
support those assets and risks. As a matter of principle,
the authorized OECD approach is the only one that
leads to an outcome that is coherent with the fiction of
independence provided in article 7(2). It is undeniable
that the single taxpayer approach does not fully accomplish
the fiction of independence of article 7(2), which
is the same as saying that it results in a partial application
of its provisions. This outcome cannot be accepted,
as it is against the rationale and wording of
article 7.
In this sense, as noted by Hans Pijl, the authorized
OECD approach is correct from the perspective of tax
treaty interpretation because the result ‘‘coincides with
the source principle ...that the state in which the activities
are carried on has the right to levy tax.’’ 102
Moreover, it is clear that, under the OECD report,
there is no presumption that the agency PE will always
generate profits. Sometimes little or no profit is attributable
to it if only routine functions are performed. As
the profits will be allocated among the relevant states
in accordance with the functions performed and the
risks assumed by the enterprise, each state will always
be entitled to tax the profits that arise from activities
carried out within its territory.
Other criticism to the authorized OECD approach
raised by Philip Baker and Richard Collier is that it
‘‘represents a significant departure from the interpretation
of article 7 as set out in the current commentary.’’
103 In other words, they argue that the current
wording of article 7 of the OECD model convention
and its commentary does not leave room for the application
of the authorized OECD approach and therefore
amendments must be made at least in the commentary.
Further, they conclude that considering the
101 Baker and Collier, supra note 7, at 57.
102 Pijl, supra note 9, at 32.
103 Baker and Collier, supra note 7, at 31.
442 • FEBRUARY 2, 2009 TAX NOTES INTERNATIONAL
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