On 4 July 2016 the OECD published a discussion draft on additional guidance on the attribution of profits to permanent establishments, as part of the follow-up to the work on base erosion and profit shifting (BEPS). Comments are invited from interested parties by 5 September 2016.

The changes made to permanent establishments by the final report on Action 7 of BEPS modified the threshold for the existence of a PE but did not change what constitutes a deemed PE. A dependent agent PE (DAPE) only applies to the extent that a person is acting on behalf of an enterprise and the PE is constituted by any activities that the person undertakes for the enterprise. The post-BEPS wording of the provision for a DAPE refers to a person who concludes contracts or plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise. This wording is a modification to the threshold for the DAPE to exist but has not modified the nature of the deemed PE.

The discussion draft refers to the effect of the transfer pricing work under BEPS actions 8 to 10 in determining the amount of profits attributable to the DAPE where the person acting on behalf of the non-resident enterprise is an associated enterprise that performs control functions related to risks contractually assumed by the non-resident enterprise.

The only effect of the changes to the exemptions in Article 5 (4) of the OECD Model is to restrict the scope of the exceptions. Also the changes in relation to splitting up contracts do not create a new type of PE but merely deny in certain cases the application of the exception of Article 5 (3) for a building site or construction or installation project. However the follow-up work on attribution of profits is not restricted to these issues but takes account of the other parts of the BEPS reports on transfer pricing including the recommendations on intangibles, allocation of risk and capital. The guidance therefore shows how the attribution of profits applies taking into account the report on Action 7 and the changes to the OECD transfer pricing guidelines.

The consultation paper notes that there are two fact patterns that would benefit from additional guidance on attribution of profits. These are:

• DAPEs especially when there are commissionaire or similar arrangements; and
• PEs arising under Article 5 (1) (fixed place of business) where the exemptions in Article 5 (4) do not apply. This could include for example a warehouse that is a fixed place of business.

The discussion draft sets out examples of these two scenarios and then comments on the issues on which input is requested from interested parties. The analysis of the examples is done by reference to Article 7 of the Model Tax Convention and commentary and the principles outlined in the OECD’s 2010 report on attribution of profits to permanent establishments which sets out the Authorized OECD Approach (AOA).

The consultation paper notes that relatively few treaties currently contain the new version of Article 7 that was included in the OECD Model in 2010. Also a number of OECD and non-OECD countries have stated their intention not to insert the new article into their own bilateral double tax agreements. The paper also notes that the UN Committee of Experts on International Cooperation in Tax Matters has rejected inclusion of the new version of Article 7 into the UN Model.

The discussion draft asks commentators whether the order in which the analyses under Article 9 and Article 7 of the OECD Model are applied can affect the outcome and what guidance should be put forward on the order of application of the analyses.

Commentators are asked to express their view on the examples presented in the paper. They are asked for comments on the functional and factual analysis on the DAPE examples; the computation of profits of the DAPE; and what would be the difference if another version of Article 7 was used in the applicable tax treaty and the AOA did not therefore apply. Questions also concern the effect of significant people functions, intangibles, financing or allocation of risk on the attribution of profits to a DAPE.

Commentators are also invited to comment on the example of a permanent establishment constituted by a fixed place of business not within any of the exemptions under Article 5 (4). The questions concern the investment return on the assets creating or forming part of the PE when there are no personnel of the non-resident enterprise operating in the PE.

Commentators are asked to comment on the approach taken where there are no functions performed in the PE apart from the economic ownership of the asset. This approach attributes profits to the PE that are commensurate with investment in the asset, taking account funding costs and compensation for investment advice.

The paper also suggests that if the non-resident enterprise has no personnel operating at the PE then any significant people functions performed by other parties on their own account in the PE’s jurisdiction do not lead to the attribution of risks or assets to the PE. Comments are invited on this point.

The consultation paper also asks commentators to suggest any further mechanisms that could provide additional coordination for the application of Article 7 and 9 of the OECD Model in determining the profits of a PE.