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30 August 2008

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Discussion draft on New Art. 7 of OECD Model – details

On 7 July 2008, the Committee on Fiscal Affairs (CFA) of the Organisation for Economic and Cooperation and Development released for public discussion a draft concerning Art. 7 (Business profits) of the OECD Model Tax Convention (MTC). This release is part of the implementation package established in the Report on the Attribution of Profits to Permanent Establishments (see). This discussion draft contains a new version of Art. 7, and a revised commentary on the principles for attributing profits to a PE under Art. 7 of the MTC (the Authorized OECD Approach, or AOA).

The CFA invited interested parties to send their comments on this discussion draft before31 December 2008 to

A summary of the main changes incorporated into the proposed article is provided below.

Para. 1

Art. 7(1) of the MTC was modified to clarify that the attribution of profits to a PE should be made in accordance with Art. 7(2).

Para. 2

(a) Article. Art. 7(2) of the MTC establishes the main rule of profits attribution to a PEs and the proposed version was re-drafted to adopt the AOA. It specifically mentions that functions performed, assets used, and risks assumed, by the enterprise through the PE must be considered for the attribution of profits to the PE.

The proposed Art. 7(2) also refer to Arts. 23A and 23B of the MTC, clarifying that such article also requires that the Residence State of the enterprise must either:


exempt the profits attributed in accordance with the AOA to the PE (Art. 23A); or


give a credit for the tax levied by the PE State on the profits attributed in accordance with the AOA to the PE (Art. 23B).

(b) Commentary. In general, the new commentary to Art. 7(2) reflects the AOA approved by the OECD Council on 17 July 2008. In this regard, the new commentary suggest that the Report will provide a detailed guide as to how the profits attributable to a PE should be determined under the provisions of Art. 7(2).

With respect to the separate and independent enterprise fiction established in Art. 7(2), the new commentary restricts this fiction to the determination of the profits of a PE, but it makes clear that this fiction would not create any notional income derived from dealings between the PE and the enterprise.

New Para. 3

A new Para. 3 is included in the new version of Art. 7, which deals with conflicts derived from the use of different methods of allocation of free capital. The proposed version of Art. 7(3) provides that the Residence State must accept the attribution of free capital derived from the method used by the PE State, if the following two conditions are met:


the difference in capital attribution between the two States must result from the use of different capital attribution methods provided by the domestic law of both States, and


the Residence State must agree that the PE State has used an authorised approach to the attribution of capital, and that that approach produces a result consistent with the arm's length principle in the particular case.

Para. 4

This paragraph is identical to the current Art. 7(7) of the MTC.

Deleted Paras

The current version of Art. 7(3) has been deleted, as the proposed Art 7(2) requires the recognition of an arm's length remuneration for the dealings between the enterprise and the PE. According to the new commentary, a deduction of an arm's length remuneration would be required for these dealings.

The previous Art. 7(4) was deleted in the proposed article because the CFA considered that the application of apportionment method had become very exceptional and it is not consistent with the arm's length principle.

The CFA also proposed the deletion of the current version of the current Art. 7(5) because:


the mere purchase of goods or merchandise for the enterprise would constitute an activity that would not constitute a PE according to Art. 5(4)(b) of the MTC; and


if the exception of Art. 5(4)(b) does not apply, an independent enterprise providing for such service would be remunerated on an arm's length basis; therefore, the paragraph in its current version is not consistent with the arm's length principle.

The current Para. 6 is also deleted from the proposed version of Art. 7 as the AOA is the only method allowed for the determination of profits of a PE; therefore, this paragraph would become superfluous.

Finally, the discussion draft includes a series of consequential changes to other parts of the commentary of the MTC.

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