ATTRIBUTION OF PROFITS TO PE:
STEP 1: APPLICABILITY OF THE DTC
- Personal scope: Art. 1(1) -> ‘person resident’ of one or both contracting states
i. Person -> Art. 3(1)(a) -> ‘includes an individual, a company and any other body of persons’
Company -> Art. 3(1)(b) -> ‘any body corporate or any entity that is treated as a
body corporate for tax purposes’
ii. Resident -> Art. 4 -> any person liable to (comprehensive) tax liability according to domestic
law (attachment criteria)
Exclusion of -> persons subject to source taxation only
A. Also includes persons that have lost residency status for treaty
purposes under the tiebreaker rule – Art. 4(2)(3)
- Material scope: Art: 2 -> ‘taxes covered’
i. Taxes on income and capital
ii. Also covers ‘any indentical or substantially similar taxes’ imposed after signature of the
treaty
- Territorial scope:
i. Not defined, has to be derived from an interpretation of the term „State“
Coastal Waters – Continental Shelf – High Seas : the continental shelf is not part of
the territory of a state even if this state has certain exploration rights on this
territory
Air Space above a territory is part of the State‘s territory (up to a certain limit)
Ships are part of the territory of a State as long as they move outside the State‘s
territory
STEP 2: EXISTENCE OF PE -> ART. 5
A. Fixed place: Art. 5(1)(2)(3) -> ‘a fixed place of business through which the business of an enterprise
is wholly or partly carried on’
ii. Place of business
At the disposal (see table of contents on Comm. Art. 5)
iii. Fixed
Geographical element (idem)
Temporal elements (6 months/12 months) (idem)
A. Exceptions: (i) recurrent activities; (ii) carried on exclusively in a
country (idem)
iv. Through which the business is wholly or partly carried on
Business carried on through (idem)
, B. Exception for Preparatory/auxiliary activities: Art. 5(4) -> ‘the term PE shall be deemed not to
include (…)’
- Paras a) to f) if they are of preparatory/auxiliary nature
i. Activity is carried out ‘for the enterprise’ or goods/merchandise ‘must belong to the
enterprise’
ii. Preparatory/auxiliary nature
C. Anti-fragmentation rule: Art. 5(4)(1) -> intended to prevent the fragmentation of activities to argue
that they each merely constitute preparatory/auxiliary activities
D. Agency PE: Art. 5(5) -> dependent agents
i. Person acting on behalf of the enterprise
ii. Habitually concludes contracts or play the principal role
iii. The contracts are in the name of or for the transfer or letting or for the provision of
services by that enterprise
E. Independent agent exception: Art. 5(6)
i. Independency (legal and economic)
Separate business
Control
Exclusivity
ii. Ordinary course of business
iii. Not acting exclusively or almost exclusively for one or more closely related enterprises
F. Parent and subsidiary corporations: Art. 5(7)
G. Closely related enterprises: Art. 5(8)
STEP 3: ALLOCATION OF INCOME123
A. AOA -> 2 step approach:
1. Functional and factual analysis
Hypothesising the PE as independent through a functional and factual analysis ->
determine the activities and conditions of the hypothetical `distinct and separate
enterprise´, engaged in `same or similar activities´ under `same or similar conditions
1
There are 2 mechanisms to attribute income to PEs:
a) Relevant business approach: the enterprise is seen as a single entity. The starting point is the worldwide profit of
the enterprise; individual income elements and expenses within this worldwide profit may be attributed to the PE.
Therefore, only actual results (income, expenses) of the general enterprise are taken into account at the level of
the PE. No notional income and losses can be attributed -> old Art. 7 (required a profit split (Art. 7(4)) between the
HQ and the PE -> aka indirect method).
b) AOA Approach: It is the approach suggested by the OECD -> new Art. 7 -> Also called the separate enterprise
approach: the PE is deemed to be an enterprise entirely separate from the general enterprise. Therefore, income
and expense items may arise that have not arise (yet) within the general enterprise, may be attributed to the PE –
deemed income and deductions
- Differences:
a) Starting point (i) Single enterprise approach: worldwide (external) profits; (ii) Separate enterprise (PE)
approach: constructed (internal) profits
b) Transactions and income (i) Single enterprise approach: Only real transactions & income accounted; (ii)
Separate enterprise approach: also deemed transactions & income accounted
2
Important: Profits attributable to a PE in accordance with Article 7 does NOT equal taxable income – the actual calculation
of taxable income is a domestic law issue
3
There are 3 important principles that underline the attribution of income:
1) Separate entity principle (separate accounts)
2) Functional analysis (taking into account: (i) functions performed, (ii) assets used, (iii) risks assumed)
3) Arm’s length principle (on internal dealings)
STEP 1: APPLICABILITY OF THE DTC
- Personal scope: Art. 1(1) -> ‘person resident’ of one or both contracting states
i. Person -> Art. 3(1)(a) -> ‘includes an individual, a company and any other body of persons’
Company -> Art. 3(1)(b) -> ‘any body corporate or any entity that is treated as a
body corporate for tax purposes’
ii. Resident -> Art. 4 -> any person liable to (comprehensive) tax liability according to domestic
law (attachment criteria)
Exclusion of -> persons subject to source taxation only
A. Also includes persons that have lost residency status for treaty
purposes under the tiebreaker rule – Art. 4(2)(3)
- Material scope: Art: 2 -> ‘taxes covered’
i. Taxes on income and capital
ii. Also covers ‘any indentical or substantially similar taxes’ imposed after signature of the
treaty
- Territorial scope:
i. Not defined, has to be derived from an interpretation of the term „State“
Coastal Waters – Continental Shelf – High Seas : the continental shelf is not part of
the territory of a state even if this state has certain exploration rights on this
territory
Air Space above a territory is part of the State‘s territory (up to a certain limit)
Ships are part of the territory of a State as long as they move outside the State‘s
territory
STEP 2: EXISTENCE OF PE -> ART. 5
A. Fixed place: Art. 5(1)(2)(3) -> ‘a fixed place of business through which the business of an enterprise
is wholly or partly carried on’
ii. Place of business
At the disposal (see table of contents on Comm. Art. 5)
iii. Fixed
Geographical element (idem)
Temporal elements (6 months/12 months) (idem)
A. Exceptions: (i) recurrent activities; (ii) carried on exclusively in a
country (idem)
iv. Through which the business is wholly or partly carried on
Business carried on through (idem)
, B. Exception for Preparatory/auxiliary activities: Art. 5(4) -> ‘the term PE shall be deemed not to
include (…)’
- Paras a) to f) if they are of preparatory/auxiliary nature
i. Activity is carried out ‘for the enterprise’ or goods/merchandise ‘must belong to the
enterprise’
ii. Preparatory/auxiliary nature
C. Anti-fragmentation rule: Art. 5(4)(1) -> intended to prevent the fragmentation of activities to argue
that they each merely constitute preparatory/auxiliary activities
D. Agency PE: Art. 5(5) -> dependent agents
i. Person acting on behalf of the enterprise
ii. Habitually concludes contracts or play the principal role
iii. The contracts are in the name of or for the transfer or letting or for the provision of
services by that enterprise
E. Independent agent exception: Art. 5(6)
i. Independency (legal and economic)
Separate business
Control
Exclusivity
ii. Ordinary course of business
iii. Not acting exclusively or almost exclusively for one or more closely related enterprises
F. Parent and subsidiary corporations: Art. 5(7)
G. Closely related enterprises: Art. 5(8)
STEP 3: ALLOCATION OF INCOME123
A. AOA -> 2 step approach:
1. Functional and factual analysis
Hypothesising the PE as independent through a functional and factual analysis ->
determine the activities and conditions of the hypothetical `distinct and separate
enterprise´, engaged in `same or similar activities´ under `same or similar conditions
1
There are 2 mechanisms to attribute income to PEs:
a) Relevant business approach: the enterprise is seen as a single entity. The starting point is the worldwide profit of
the enterprise; individual income elements and expenses within this worldwide profit may be attributed to the PE.
Therefore, only actual results (income, expenses) of the general enterprise are taken into account at the level of
the PE. No notional income and losses can be attributed -> old Art. 7 (required a profit split (Art. 7(4)) between the
HQ and the PE -> aka indirect method).
b) AOA Approach: It is the approach suggested by the OECD -> new Art. 7 -> Also called the separate enterprise
approach: the PE is deemed to be an enterprise entirely separate from the general enterprise. Therefore, income
and expense items may arise that have not arise (yet) within the general enterprise, may be attributed to the PE –
deemed income and deductions
- Differences:
a) Starting point (i) Single enterprise approach: worldwide (external) profits; (ii) Separate enterprise (PE)
approach: constructed (internal) profits
b) Transactions and income (i) Single enterprise approach: Only real transactions & income accounted; (ii)
Separate enterprise approach: also deemed transactions & income accounted
2
Important: Profits attributable to a PE in accordance with Article 7 does NOT equal taxable income – the actual calculation
of taxable income is a domestic law issue
3
There are 3 important principles that underline the attribution of income:
1) Separate entity principle (separate accounts)
2) Functional analysis (taking into account: (i) functions performed, (ii) assets used, (iii) risks assumed)
3) Arm’s length principle (on internal dealings)
