On The Approaches To Attribute Profits To Permanent Establishment

The most popular principle in the taxation of international profits is the principle of permanent establishment, which means the profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that permanent establishment. This concept covers two aspects: one is that materially the host country can tax the foreign enterprises only if they carry on business in the host country through a permanent establishment situated therein; the other is that numerically the profits of the enterprise may be taxed in the host country but only so much of them as is attributable to that permanent establishment. The latter is what'sdiscussed in this article------the methods of attributing profits to the PEs. There havebeen several methods which were and are suggested in the model conventions on international taxations. In view of that the OECD has recently issued the , which makes some revise to the former relative regulations and brings in some new points, this article puts emphasizes on the functionally separate entity approach, namely where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment 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 permanent establishment. It includes two steps: firstly to make a hypothesis of a distinct and separate entity, next to apply by analogy the transfer pricing methods applied to the related enterprises to the PEs. These two steps include many issues, mainly that how to attribute assets, functions, risks and free capital to the PEs, and how to define and price various dealings concerned to the PEs. The functionally separate entity approach has its feasibility and advancement, and has been used by most tax treaties. The development made by the OECD in the latest report, however, should be slowed down for its thouroughly independent hypothesis of the PEs and the extreme outcome in attributing profits to PEs.