9.

38 Permanent Establishments

EXPOSURE TO TAX WHERE THE PE IS LOCATED

9.38 Note: in this section, the term ‘company’ is used, but the principles set
out apply to any type of enterprise.
If a company resident in State A has a PE located in State B, then State B is
entitled to tax the profits attributable to the PE. This does not mean that State
B can tax all of the profits of the company that arise from business which it
carries on in State B but rather only so much as is attributable to the PE. For
instance, the company may have a factory in State B which would clearly con-
stitute a PE but it may also maintain a warehouse for products other than those
produced by that factory which is operated by different personnel to those
employed at the factory and at a different location. It may sell certain of its
products (not the ones produced by the factory) in State B through independent
agents who are resident in State B. Only the profits arising from the factory are
attributable to a PE and thus these are the only profits of the company which
State B may tax, even though they are not the only profits which the company
is making in State B.
Some existing treaties, particularly those based on the UN Model contain lim-
ited provisions which extend the right of the host state to tax beyond the profits
directly attributable to the PE. These are known as ‘force of attraction’ provi-
sions, because the existence of the PE attracts other profits of the company into
the host state’s tax net and are discussed below under the paragraphs dealing
with the UN Model.

The authorized OECD approach (AOA)

9.39 Before setting out the details of the methods advocated by the OECD
to attribution of profits to a PE, readers should note that the OECD’s methods
(AOA) have been heavily criticized during the course of the BEPS Project
work on PEs. The AOA is felt to be difficult to apply. There is a lack of detailed
guidance on how to apply it, except for companies in the financial services
­sector. Also, because of its complexity, many countries have not implemented
it, leading to many different methods used around the world in attributing prof-
its to a PE.
9.40 The starting point for any attribution of profits to a PE is the branch
accounts. However, in some cases the host state will wish to amend the ­profits
shown in the branch accounts in accordance with the general principle for
attribution of profits set out in the relevant DTT.
Article 7, para 2 of the Model current as at August 2011 states that the profits
attributable to a PE are:
‘the profits it might be expected to make, in particular in its dealings
with other parts of the enterprise, if it were a separate and independ-
ent enterprise engaged in the same or similar activities under the same
or similar conditions, taking into account the functions performed,

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