Exposure to tax where the PE is located 9.

40

assets used and risks assumed by the enterprise through the perma-
nent establishment and through the other parts of the enterprise.’
This wording reflects a lengthy process of consultation and development and
replaced the much simpler wording which existed until 2008:
‘the profits which it might be expected to make if it were a distinct
and 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.’
The reason for the change was that the OECD perceived that there was consid-
erable uncertainty as to how it should be implemented. Some states believe that
it is correct to look at the profits of the company as a whole and decide how
much of them are to be attributed to the PE. Others believe that the PE should
be viewed as a functionally separate enterprise and its profits determined with-
out reference to the profits of the company as a whole. This uncertainty is
evidenced by a whole series of consultations, draft reports, updates and reports
issued by the OECD over the last couple of decades (see for example, the 1993
report Attribution of Income to PEs).1
In 2008 the OECD published its final report setting out a complete overhaul
of the approach to the interpretation of Article 7 of the Model,2 which sets out
how profits of an enterprise are to be attributed to a PE (and thus taxable by the
host state). The OECD had published landmark guidance on transfer pricing
in 1995, and following that, the outcome of the OECD’s work on the effect
of e-commerce on the taxing rights of various states in which an enterprise
operated. Many had expected that the work on attribution of profits to PEs
would follow on directly after the publication of the transfer pricing guide-
lines, but the need to deal with the tax effects of e-commerce was found to
be more pressing. In the event, the main outcome of the work on e-commerce
was merely to confirm that what was really needed were better principles for
dealing with the attribution of profits to any sort of PE, e-commerce related or
otherwise. A Discussion Draft released by the OECD in 20013 went to some
lengths to set out a ‘working hypothesis’ for the attribution of profits to a PE
using the hypothesis that the PE is a ‘distinct and separate enterprise’ rather
than any approach which merely attempts to apportion the total profits of the
firm. Thus the approach to the attribution of profits to a PE places heavy reli-
ance on the content of the OECD’s transfer pricing principles (see Chapter 13).
These principles are aimed at transactions between companies in the same cor-
porate group. The OECD recognizes that dealings between different parts of
the same company (eg head office and branch) are not the same as transactions
between companies in the same corporate group but has stated that the transfer
pricing principles apply by analogy. The July 2008 Report was the culmina-
tion of a series of discussion documents and draft reports produced from 2001
onwards. The OECD has declared that the question of attributing profits to PEs
is to be determined without being constrained either by the original intent or
any historical interpretation of Article 7.4
The new approach was introduced by the OECD in two stages: in 2008, new
material was introduced into the Commentary, which did not conflict with

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