Defining the personality of permanent establishments under former Article 7 and the pre-2008 Commentary and the 2008 Commentary

Abstract

Introduction Former Article 7 establishes a long-standing treaty principle for allocating the business profits of an international enterprise operating through permanent establishments. The rationale underlying former Article 7 is that when an enterprise operates in a host country through a permanent establishment, the enterprise is participating in the economic life of that country. Consequently, former Article 7 allocates to a host country taxing rights over business profits attributable to a permanent establishment in the host country. Former Article 7 is based on the arm's length principle and purports to treat a permanent establishment as a separate entity for the purpose of allocating profits and expenses to it. Prior to the publication of the 2008 Commentary on former Article 7 there was no OECD consensus interpretation of the provision, despite the revision of the Commentary in 1994. This led to the OECD issuing a series of discussion drafts on former Article 7 resulting in the publication in July 2008 of the ‘authorized OECD approach’ on interpreting former Article 7 – the consensus interpretation – in the 2008 Report. In order to quickly adopt the 2008 Report, the OECD used a two-step implementation procedure, which has created uncertainty. In the first step, in 2008 the OECD amended the Commentary on former Article 7 (2008 Commentary) which implemented the parts of the ‘authorized OECD approach’ in the 2008 Report that do not conflict with the pre-existing version of the Commentary (pre-2008 Commentary). This approach implies that the 2008 Commentary may be used to interpret the business profits Article of tax treaties concluded before July 2008. It is bold for the OECD to claim that the ‘authorized OECD approach’, which is a new interpretation, can be immediately applied to tax treaties finalized before July 2008 on the unconvincing claim that the authorized OECD approach in the 2008 Commentary does not conflict with the pre-2008 Commentary. The authorized OECD approach is a new interpretation of former Article 7 which was established after several years of discussions by OECD countries.