Article 7


Fowler v Commissioners for Her Majesty’s Revenue and Customs, [2020] UKSC 22

UK domestic provision deeming employee to be independent contractor did not engage Art. 7

A U.K. domestic income tax provision deemed the diving activities of a South African resident in the North Sea to be the carrying on of a U.K trade, notwithstanding that in fact he was an employee. A majority of the Court of Appeal of England and Wales found that this meant that his earnings were business profits for purposes of Art. 7 of the U.K-South Africa Treaty (rather than employment income under Art. 14) so that they escaped U.K. taxation (as he had no U.K. permanent establishment.)

In reversing this decision, Lord Briggs stated (at para. 30):

Nothing in the Treaty requires articles 7 and 14 to be applied to the fictional, deemed world which may be created by UK income tax legislation. Rather they are to be applied to the real world, unless the effect of article 3(2) is that a deeming provision alters the meaning which relevant terms of the Treaty would otherwise have.

He noted (at para. 33) that the UK domestic deeming provision instead only had a limited purposes, which was to give the diver access to more generous deductions from income, and stated that to apply this limited “deeming provision … so as to alter the meaning of terms in the Treaty with the result of rendering a qualifying diver immune from UK taxation would be contrary to its purpose.”

Locations of other summaries Wordcount
Tax Topics - Treaties - Income Tax Conventions - Article 3 deeming an employee to be an independent contractor did not oust the Treaty Employment Income Article 462
Tax Topics - Statutory Interpretation - Interpretation/Definition Provisions principles in determining the scope of a deeming provision 367

Fowler v HM Revenue and Customs, [2018] EWCA Civ 2544, rev'd 2020 UKSC 22

employment income deemed by domestic provision to be business profits

A U.K. domestic income tax provision deemed the diving activities of a South African resident in the North Sea to be the carrying on of a U.K trade, notwithstanding that in fact he was an employee. The majority of the Court of Appeal of England and Wales found that this meant that his earnings were business profits for purposes of Art. 7 of the U.K-South Africa Treaty (rather than employment income under Art. 14) so that they escaped U.K. taxation (as he had no U.K. permanent establishment.)

Both Lord Justices in the majority treated the domestic deeming provision (which merely deemed the underlying activity to be a trading activity rather than explicitly deeming the resulting income to be “profits” of an enterprise) as having effect for Treaty purposes.

Locations of other summaries Wordcount
Tax Topics - Treaties - Income Tax Conventions - Article 3 a domestic provision deeming employment income to be from trade rendered it business profits for Treaty purposes 517
Tax Topics - Statutory Interpretation - Interpretation/Definition Provisions domestic deeming provision had Treaty effect 294

Gulfmark offshore N.S. Limited v. Canada, 2007 DTC 5563, 2007 FCA 302

Before the taxation year in question, the taxpayer, which was a U.K. company with a fleet of 27 supply vessels including a ship that was operated for 88 days in that year in the Nova Scotia offshore area, borrowed money from its parent company to construct new ships in addition to the refinancing of the taxpayer's outstanding debts. The taxpayer was unable to deduct any portion of the interest on the loan from its parent in the absence of more complete evidence on how that loan was used.

Cudd Pressure Control Inc. v. Canada, 98 DTC 6630 (FCA)

notional separate enterprise would not have rented the equipment

The taxpayer, which was resident in the United States, entered into a contract to provide two "snubbing" units to Mobil Oil Canada Ltd. for use in connection with an underground blowout in an exploratory gas well off the coast of Nova Scotia, at a rate of U.S. $15,000 per day. In computing its Canadian profits for Canadian income tax purposes, the taxpayer deducted an amount for notional rent. The finding of the Tax Court Judge that, in the circumstances, it was more reasonable to assume that the Canadian branch would have purchased the snubbing unit (claiming capital cost allowance, rather than a rent deduction) was affirmed. MacDonald JA stated (at para. 29):

The 1942 Convention requires that one consider what an "independent enterprise engaged in the same or similar conditions would do." Given the unique nature of the business conducted by the appellant's head office (i.e. it owned the only 600 unit in the world), it is highly unlikely that an independent enterprise would have rented the 600 unit from the head office, particularly in light of the high rental costs, and then have used it to provide snubbing services to another company, in this case Mobil. Instead, given the nature of the business and the type of equipment at issue, the head office would have been contracted directly to take on the project in question. It is not reasonable to believe that an independent third party would have contemplated entering into this type of contract given it did not have the required equipment and would have incurred exorbitant expense if it chose to rent the equipment.

Utah Mines Ltd. v. The Queen, 92 DTC 6194, [1992] 1 CTC 306 (FCA)

The taxpayer, which was a U.S. corporation with a mining operation in B.C., was prohibited by s. 18(1)(m) from deducting royalties payable by it to the Province of B.C. notwithstanding the provisions of the 1942 Canada-U.S. Income Tax Convention which provided that in determining the net industrial and commercial profits of a permanent establishment there shall be allowed as deductions all expenses reasonably allocable to the permanent establishment. Hugessen J.A. stated (p. 6197):

"The interpretation proposed by the appellant ... would have the effect of giving a U.S. taxpayer with a permanent establishment in Canada a more favourable tax treatment than its Canadian competitor engaged in the same business in this country. Such a result would not be in accordance with the policy expressed in the preamble to the Convention ..."

Sun Life Assurance Co. of Canada v. Pearson, 1986 BTC 282 (C.A.)

A statutory method of allocation whereby the portion of the gross profits of a Canadian life insurance company attributable to its U.K. branch were determined (that determination being based on the ratio of the company's liability to U.K. policyholders to its liability worldwide) then the actual expenses of the branch deducted from that gross profit figure, was found to be an acceptable measure of the net profit that the branch would have earned as an independent enterprise. (1980 Canada-U.K. Convention, Article 7(4))

It was also stated that the word "profits" in Article 7 means "income" rather than "income less expenses".

Abed Estate v. The Queen, 82 DTC 6099, [1982] CTC 115 (FCA)

The exemption in Article I of the 1942 Canada - U.S. Convention, for the commercial profits of a U.S. enterprise that are not attributable to a Canadian permanent establishment, did not apply to the Canadian profits of a U.S. resident that were not attributable to an enterprise or undertaking carried on in the United States. Here, the U.S. - resident appellant was not exempt because he never had any business activities in the United States, and he accordingly was taxable under what is now S.2(3)(b) on his profits from trading in Montreal real estate.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 12 - Subsection 12(1) - Paragraph 12(1)(e) no requirement to include a reserve if no evidence of its claiming in previous sale year 160
Tax Topics - Income Tax Act - Section 152 - Subsection 152(7) 133
Tax Topics - Income Tax Act - Section 20 - Subsection 20(1) - Paragraph 20(1)(n) taxpayer did not object to Minister deducting reserve 159

Loeck v. The Queen, 78 DTC 6368, [1978] CTC 528 (FCTD), aff'd 82 DTC 6071, [1982] CTC 64 (FCA)

The German plaintiff owned and managed property in Hamburg that contained 17 rented apartments, and he was a shareholder in a public company that operated residential properties in West Berlin. It was held that gains from the sale of properties owned by him in Ontario were not the profits of a West German enterprise.

Ostime v. Australian Mutual Provident Society (1959), 38 TC 492 (HL)

Rule 3 applicable to Case III of Schedule D of the Income Tax Act, 1918 provided that a life insurance company with a head office overseas (in this case, in Australia) should pay tax on a proportion of its world-wide income from investments, determined on the basis of premiums received in the United Kingdom as a percentage of all its premium income. Lord Radcliffe held that this method of computation was inconsistent with the independent enterprise hypothesis contained in Article III(3) of the U.K.-Australia Convention.

See Also

Vincent v. Agence du revenu du Québec, 2020 QCCQ 3605

use of the firm’s Quebec establishments imputed to a “silent” partner, who had departed from KPMG Canada to France, in ousting a Quebec-France Treaty exemption

From 2001 to May 2012, the taxpayer (“Vincent”), who was a lawyer and a Quebec resident, was a partner of KPMG Canada. He became a resident of France and started working at KPMG France thereafter until October 2015, when he moved to Chicago to become a partner of KPMG U.S. Despite his departure, Vincent received payments from KPMG Canada of $84,721 for 2013 and $58,936 for 2014, which were described in the Quebec tax-reporting slips issued by KPMG Canada as having been paid to him as a “silent partner” (“associé passif”). He was unsuccessful in getting KPMG Canada to change this description on the slips.

Article 14 of the Income Tax Convention between France and Quebec only exempted income derived by a resident of France from a “liberal profession” (such as law) where such income did not relate to a fixed base used by the French resident in Quebec in exercising such profession. After quoting a statement in Dunne, 2005 QCCA 739, at para. 28 that “when dealing with a firm, all the members, including a member not residing in Quebec, carry on the business of the firm and thereby exploit all of the firm’s establishments there,” Lareau JCQ stated (at para. 20) that the “question of whether or not Vincent is a member of KPMG Canada in 2013 and 2014 therefore becomes determinative in resolving this dispute” (TaxInterpretations translations).

As the taxpayer did not provide any evidence on this point other than a copy of his letter of resignation, the taxpayer failed to make this case, and his appeal was dismissed.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 96 - Subsection 96(1) - Paragraph 96(1)(f) non-resident retired silent partner was a partner of Canadian firm 372

Irish Bank Resolution Corporation Ltd v Revenue and Customs, [2020] EWCA Civ 1128

interest expenses of PE could be reduced if it had insufficient free capital compared to the arm’s length standard

The Irish taxpayers, which carried on a UK branch banking business or a business of financing UK house purchases, were required to determine their profits under UK taxing legislation which, in this regard, was generally similar to the “comparator provisions” of Art. 8(2) of the 1976 Ireland-UK Treaty (which required that there be attributed to a UK permanent establishment (“PE”) “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 at arm's length with the enterprise of which it is a permanent establishment”) except that the UK legislation went on to provide that, in applying this test, “it shall also be assumed that the permanent establishment has such equity and loan capital as it could reasonably be expected to have in the circumstances specified” above.

In applying the domestic provision, HMRC attributed to the PEs notional additional free capital on the basis that if they had operated as distinct and separate enterprises, they would have had a higher amount of free capital and therefore a correspondingly lower amount of borrowed capital – with the result that HMRC disallowed interest which was actually paid to third parties.

The taxpayers unsuccessfully argued (as summarized at para. 11) that:

[T]he reference in Article 8(2) to the PE being treated as a distinct and separate enterprise "engaged in the same or similar activities under the same or similar conditions" requires an assumption to be made not only that the PE is engaged in the same or similar type of business to the one it actually carried on but also that it should be taken to have traded with the same ratio of free to borrowed capital as it actually employed during the relevant accounting period.

In this regard, Patten LJ noted that the previous more favourable practice of HMRC was not relevant, noting (at para. 23) that the taxpayers were “unable to identify any established principle of international law which recognises the unilateral practice of a contracting state as an aid to the construction of a treaty.” After also noting (at para. 29) that the 2008 OECD commentary stated that “authorised OECD approach does not limit the methods by which domestic tax regimes may seek to implement the provisions of Article 7 and that the attribution of capital is a well-recognised and justifiable method of attributing profits to a branch of an overseas bank,” he stated (at para. 39):

In order to operate the hypothesis of a distinct and separate enterprise dealing at arm's length including with the overseas company of which it is part, it seems to me that it is necessary to compare the way in which the PE financed and accounted for its business with what it would have done had the PE operated as a separate enterprise. Otherwise the comparator provisions of Article 8(2) cannot work. To construe the phrase "same or similar conditions" as requiring the PE's actual ratio of free to borrowed capital to be applied would be self-defeating.

Accordingly the appeals were dismissed.

Locations of other summaries Wordcount
Tax Topics - Treaties - Income Tax Conventions subsequently-added material in OECD Commentaries could be reviewed if they were not inconsistent with contemporaneous commentaries 228

GE Energy Parts Inc. v. Commissioner of Income Tax (International Taxation), ITA 621/2017, 21 December 2018 (High Court of Delhi)

portion of profits attributable to marketing estimated at 26%

Various non-resident General Electric companies employed non-resident employees (the “expatriates”) in an office in India to secure customers and negotiate contracts with them. Bhat J found that as this was an intensive process, their services were not merely of “a preparatory or auxiliary character,” and the office constituted a fixed place of business and, thus, a permanent establishment for purposes of the India-U.S. Convention.

Bhat J accepted a finding below that, in the absence of any evidence of the profits generated from the sales in India, they should be estimated at 10% of such sales, and that 26% of this profit was attributable to the operations carried out by the PE in India.

Locations of other summaries Wordcount
Tax Topics - Treaties - Income Tax Conventions - Article 4 GE U.S. companies had a PE in India based on the intensive negotiation of their employees in India in contact negotiations 326

Adobe Systems Inc. v. ADIT, W.P.(C) 2384/2013 (Delhi High Court)

no ability to tax US resident on fees of Indian sub which already were subject to tax in accordance with the arm's length pricing standard

The taxpayer, which was a U.S.-resident corporation not having any business operations in India, received software-related research and development (R&D) services on a cost plus 15% basis from its wholly-owned Indian subsidiary ("Adobe India"). For the third assessment year in question (2006-2007), Adobe India had successfully appealed, to the Income Tax Appellate Tribunal, an assessment made on it on the basis that its cost-plus pricing for its services did not accord with the arm’s length standard, and an appeal of this decision before the High Court of Delhi was pending.

In rejecting the assessment officer’s position that the activities carried on by Adobe India were part of the taxpayer’s core business activities carried on through Adobe India as its permanent establishment, and that the taxpayer was subject to Indian income tax on a portion of its global profits based on the fraction of global R&D expenditures represented by those expended in India, Bakhru J stated (at paras. 23):

[T]here is no dispute that Adobe India - which according to the AO is the Assessee’s PE – has been independently taxed on income from R&D services and such tax has been computed on the basis that its dealings with the Assessee are at arm’s length (that is, at ALP). Therefore, even if Adobe India is considered to be the Assessee’s PE, the entire income which could be brought in the net of tax in in the hands of the Assesee has already been so taxed in the hands of Adobe India … Thus…the facts in this case do not provide the AO any reason to believe that any part of the Assessee’s income has escaped assessment under the Act.

Locations of other summaries Wordcount
Tax Topics - Treaties - Income Tax Conventions - Article 5 not carrying on business "through" sub's premises if no right to use them 492

AB LLC and BD Holdings LLC v. Commrs. of South African Revenue Services, Case No. 13276, 15 May 2015, South Africa Tax Court

subsequently earned success fee of consultant attributable to previous PE

A US corporation, which spent 15 months based in the boardroom in South Africa of a South African client providing consulting services argued unsuccessfully that it did not have a permanent establishment in South Africa. Vally J went on to find that a success fee received by the taxpayer in a subsequent taxation year during which it had no presence in South Africa was "attributable" to its previous permanent establishment there, and therefore was not exempted from South African tax.

See summary under Treaties – Art. 5.

Locations of other summaries Wordcount
Tax Topics - Treaties - Income Tax Conventions - Article 5 services PE was not required to be a fixed place of business – and a client boardroom so qualified anyway/double counting of days for 183-day test permitted 563

Samuel Wuslich v. Minister of National Revenue, 91 DTC 704, [1991] 1 CTC 2473 (TCC)

In addition to carrying on an orthodontic practice at various locations in the U.S., the taxpayer also maintained a professional office in Regina. Although examinations and consultations of patients were carried out there, he reviewed his records, prepared treatment plans, fabricated retainers, ordered supplies and carried out administrative functions from his office in Pittsburgh. The profits arising from his Regina practice were allocated between Canada and the U.S. on the basis of the time spent in Pittsburgh on the latter functions compared to the total time spent by him in relation to his Regina practice.

Locations of other summaries Wordcount
Tax Topics - General Concepts - Illegality 35

Administrative Policy

26 May 2016 IFA Roundtable Q. 2, 2016-0642061C6 - AOA & Notional Expenses

no deduction of notional expenses from the profits of PEs of (non-U.S.) non-residents

Notwithstanding the new wording of Article 7 of the OECD Model Convention and the OECD commentary thereon, CRA continues to consider (in light of Cudd Pressure and s. 4(b) of the Income Tax Conventions Interpretations Act) that notional expenses are not deductible in computing the profits attributable to a Canadian permanent establishment for Treaty purposes – with the exception of PEs of qualifying U.S. residents, as to which there is an agreement with the U.S. competent authority which overrides s. 4(b) of the ITCIA.

Neal Armstrong. Summary of 26 May 2016 IFA Roundtable, Q. 2 under Treaties – Art. 7.

20 November 2014 Internal T.I. 2014-0539631I7 - Restrictive Covenants-Part XIII (Luxembourg)

restrictive covenant payment not eligible for relief under Lux Treaty

After CanCo had sold shares of a partly-owned subsidiary (SubCo), it made a payment to the other share vendor (LuxCo) pursuant to what was assumed to be a "restrictive covenant" in a related agreement, and withheld and remitted 25% of the payment. Luxco was unsuccessful in a refund claim based inter alia on Art. 7 of the Canada-Luxembourg Treaty. CRA noted that although it used the term "profits" rather than "business profits," under Art. 3, para. 1(c) of the OECD Model, the term "enterprise" applies to the "carrying on of any business," so that the reference to "profits of an enterprise" means profits from carrying on a business. Given that the shares of SubCo were held by LuxCo on account of capital, there was no reason to believe the payment constituted income from a business.

See summary under Treaties - Art. 22.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 56.4 - Subsection 56.4(1) - Restrictive Covenant restrictive covenant definition is broad 102
Tax Topics - Treaties - Income Tax Conventions - Article 22 restrictive covenant payment not eligible for relief under Lux Treaty 266

Canada-U.S. Income Tax Convention - Agreement between Competent Authorities on the interpretation of Article VII (Business Profits) CRA Notice dated 19 July 2012

The competent authorities of Canada and the US agreed on 26 June 2012 pursuant to Article XXVI, para. 3 (resolution of interpretive doubt), that Article VII of the Canada-US Income Tax Convention is to be interpreted consistently with the OECD 2010 Report on the Attribution of Profits to Permanent Establishments.

14 November 2007 External T.I. 2007-0253321E5 - Non-resident withholding tax

Respecting whether franchise fees paid to a U.S. resident were subject to withholding tax, the Directorate stated that:

"Where a payment represents in part a royalty and in part business profits for purposes of the Treaty, a taxpayer must make reasonable efforts to separate the two. Where a taxpayer fails to, or is unable to, identify the royalty component with the business profits component, the entire payment will be taxed as a royalty ... ."

17 January 1996 External T.I. 9520065 - BORROWINGS EFFECTIVELY CONNECTED TO A PE

Before indicating that borrowings by a U.S. Parent to acquire flow-through shares issued by one of its wholly-owned subsidiaries would not be considered to be attributable to the assets or activities of a permanent establishment of the U.S. parent in Canada through which it carried on business (with the result that the resulting interest expense would not be deductible in computing the income of the permanent establishment), RC stated that "the meaning of the term 'attributable to' as used in paragraph 7 of Article VII of the Treaty has the same meaning as the term 'effectively connected' as used in Articles X, XI and XII of the Treaty since in both cases the term is relating the income or the income source to the PE of U.S. Co."

10 May 1995 External T.I. 9332355 - CAPITAL GAINS

The Canada-Denmark Convention does not deal with the taxation of capital gains. Accordingly, the transfer of shares of a Canadian private company from one Danish corporation to a related Danish corporation (on a basis that would not be subject to tax in Denmark) would be subject to tax under the Act with no relief provided by the Convention.

16 March 1993 T.I. (Tax Window, No. 30, p. 15, ¶2478)

Payment to a U.S.-resident engineer for his services would be exempt from Part XIII tax if such payments did not fall within Article XII of the U.S. Convention.

6 January 1992 T.I. (Tax Window, No. 15, p. 14, ¶1679)

Re taxability of rental payments derived from the use of moveable property in Canada by a Norwegian limited partnership.

Locations of other summaries Wordcount
Tax Topics - Treaties - Income Tax Conventions - Article 3 129

IC 87-2 "International Transfer Pricing and Other International Transactions", para. 32

Most treaties do not require that management fees be treated as anything other than a component of industrial, commercial or business profits.

IT-468R "Management or Administration Fees Paid to Non-Residents"

Where the treaty does not contain a specific article on management or administration fees, such fees paid to the non-resident will, to the extent they are reasonable, be considered to be covered by the business profits article.


Nathan Boidman, "How Will Revised Sourcing Rules Affect Sales of U.S.-Made Goods Abroad?", Tax Notes International, 10 February 2020, p. 655

Treaty-limits on what Canada may tax on sales by U.S. into Canada (p.658)

Under the prior version of Code s. 863, the gross revenue of a U.S. person from goods produced by it in the U.S. and sold outside the U.S. could often be allocated partly to the other country for U.S. foreign tax credit (FTC) purposes. Revised s. 863 allocates all gross revenue from production and sales to the place of production (the U.S.) for FTC purposes. This has the effect of eliminating FTCs for any income tax that is imposed by the other country on the profits of the sales transaction, thereby triggering double taxation where such taxes are imposed in accordance with any applicable Treaty limitations (e.g., under Art. VII of the Canada-U.S. Treaty). In this regard, Mr. Boidman stated:

[T]he portion of the USA seller’s overall profit that Canada may tax is determined by the language in Article VII, as explained by the Treasury’s Technical Explanation (which Canada accepts as reflecting the intention of the parties) and an OECD–related competent authority agreement... .

Section 9 of Annex B to the 2007 protocol states that the two countries “understood that the business profits to be attributed to a permanent establishment shall include only the profits derived from the assets used, risks assumed and activities performed by the permanent establishment. The principles of the OECD transfer pricing guidelines shall apply for purposes of determining the profits attributable to a permanent establishment....”. In light of the OECD's subsequent publication of the “[Authorized OECD Approach”] AOA and the principle therein - that is, that the profits attributable are those the PE would have made were it a separate legal entity (for example, a corporate subsidiary) - the two countries then signed a competent authority agreement on June 26, 2012 that adopts the AOA. See ... CRA “Canada – US Tax Convention – Agreement between Competent Authorities on the Interpretation of Article V11 (Business Profits)”, (June 26, 2012). The bottom line is that a U.S. seller operating through a Canadian PE has firm guidelines to use to determine the amount of tax that the treaty will allow Canada to impose on profits derived from producing goods in the United States and selling them in Canada.

Joshua Lawrence, "New York Nexus Widens", Canadian Tax Highlights, Vol. 22, No. 8, August 2014, p. 1.

No physical nexus under NY franchise tax (p.1)

[U]nder New York's new nexus standard, any corporation "deriving receipts from activity" within New York is subject to franchise tax obligations if its New York receipts total at least $1 million for the taxable year, even if it has no physical presence in the state. However, a non-USco—even if it meets the receipts-based threshold—is subject to franchise tax under the new law only if it also has ECI for federal purposes or if it is a deemed domestic corporation such as a stapled stock entity) under the Code…

No PE exemption (p.1)

A Canco that lacks a US PE currently enjoys protection from US federal income tax under the Canada-US treaty, but treaty protection does not extend to the taxes of an individual state. New York State generally requires that a non-USco with sufficient nexus pay franchise tax on an apportioned amount of its entire net income (ENI)….

Exemption if no ECI (p.1)

Effective in 2015, only a non-USco's ECI is included in its New York ENI. However, for the purposes of the new economic nexus threshold, it is irrelevant whether the ECI is associated with a trade or business carried on in New York or in other states, or whether the corporation has ever had property, employees, inventory, or any other form of physical presence in New York;…

Michael Kobetsky, "Inter-Bank Loans: Determining a Branch's Business Profits Under Article 7 of the OECD Model", International Bureau for Fiscal Documentation, February 2005, p. 48.

David A. Ward, "Attribution of Income to Permanent Establishments", Canadian Tax Journal, Vol. 48, No. 3, 2000, p. 559.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 10 - Subsection 10(2) 0

Purdy, Zanchelli, "Calculating and Supporting Management Fees (A Departure from the 'Back of the Envelope' Approach)", International Tax Planning, 1996 Canadian Tax Journal, Vol. 44, No. 1, p. 157.

Markovitz, "Permanent Establishment - Home Office Relations", International Tax Planning, 1996 Canadian Tax Journal, Vol. 44, No. 4, p. 1127.


OECD, 2010 Report on the Attribution of Profits to Permanent Establishments, 22 July 2010:

Part I: General Considerations

B-1 The "functionally separate entity approach"

"[T]here should be no 'force of attraction principle'....Profits may therefore be attributed to a permanent establishment even though the enterprise as a whole has never made profits" (para.8).

B-2 Basic premise of the authorised OECD approach

"[T]he authorised OECD approach is not designed to prevent the application of any domestic legislation aimed at preventing abuse of tax losses or tax credits by shifting the location of assets or risks" (para. 9).

"[A] two-step analysis is required. First...[a] functional and factual analysis must identify the economically significant activities and responsibilities undertaken by the PE....Under the second step, the remuneration of any dealings between the hypothesised enterprises is determined by applying the analogy the Article 9 transfer pricing tools...." (para. 10).

B-3 Step one: hypothesising the PE as a separate and independent enterprise

"[T]he authorised OECD approach attributes to the PE those risks for which the significant functions relevant to the assumption and/or management (subsequent to the transfer) of risks are performed by people in the PE and also attributes to the PE economic ownership of assets for which the significant functions relevant to the economic ownership of assets are performed by people in the PE" (para. 15).

"[I]n the case of financial assets of financial enterprises, the same significant people functions wil generally be relevant both to the assumption of risk and to the economic ownership of those assets....Because of the special relationship between risks and financial assets in these specific sectors, the authorised OECD approach uses the 'key entrepreneurial risk-taking function ( 'KERT function') terminology in describing the functions relevant to the attribution of both risks and assets..." (para.16).

"The functional and factual analysis will attribute 'free' capital (i.e. funding that does not give rise to a tax deductible return in the nature of interest) to the PE for tax purposes, to ensure an arm's length attribution of profits to the PE. The starting point for the attribution of capital is that under the arm's length principle a PE should have sufficient capital to support the functions it undertakes, the assets it economically owns and the risks it assumes. In the financial sector regulations stipulate minimum levels of regulatory capital to provide a cushion in the event that some of the risks inherent in the business crystallize into financial loss. Capital provides a similar cushion against crystallization of risk in non-financial sectors" (para.28).

"[C]apital needed to support risks is to be attributed to a PE by reference to the risks attributed to it and not the other way around" (para. 29).

"Save in exceptional circumstances...dealings between a PE and the rest of the enterprise...should be priced on the basis that both share the same creditworthiness" (para. 33).

B-4 Step two: determining the profits of the hypothesised separate and independent enterprise based upon a comparability analysis

Tax administrations should give effect to contemporaneous documentation of dealings between the PE and the rest of the enterprise provided various conditions are satisfied including that "the documentation is consistent with the economic substance of the activities taking place" and the documented arrangements "do not deffer from those which would have been adopted by comparable independent enterprises behaving in a commercially manner or, if they do so differ...reasonably accurate adjustments can be made to eliminate the material effects of such differences" (para. 36, 40).

B-5 Summary of the two-step analysis

Summary of two-step approach in para. 44-45.

D-2 First step: determining the activities and conditions of the hypothesised separate and independent enterprise

"The guidance in the [Transfer Pricing] Guidelines on functional analysis seems capable of being applied fairly directly in the PE context in order to determine the 'activities' of the hypothesised separate and independent enterprise. The main difficulties are with determining how to take into account risks assumed and assets used" (para. 61).

"[W]here it is accepted that the location of a server of itself constitutes a PE...the same principles apply and the functional analysis will determine what automated functions are performed by the server-PE and what assets are used and risks assumed in the performance of those functions" (para. 66).

'A PE may 'assume' a risk and may subsequently use the services of another part of the enterprise to 'manage' that risk, without necessarily transferring the risk to that other part of the enterprise to 'manage' that risk" (para. 70).

"The amount and nature of the risks assumed by the PE also affects the amount of capital that needs to be attributed to the PE. This is because an enterprise assuming material additional risks would need to increase its capital correspondingly in order to maintain the same creditworthiness. This is most clearly seen in the financial sector..." (para. 71).

"Economic ownership of an asset is determined by a functional and factual analysis and in particular rests upon performance of the significant people functions relevant to ownership of the asset..." (para. 72).

"[T]here was a broad consensus among the OECD member countries for applying use [as contrasted to significant people functions] as the basis for attributing economic ownership of tangible assets in the absence of circumstances that warrant a different view" (para. 75).

"The functional and factual analysis [respecting internally developed intangible property] should therefore describe and evaluate the dynamics of the particular enterprise's research and development programme....[F]unctions which may be relevant include designing the testing specifications and processes within which the research is conducted, reviewing and evaluation the data produced by the tests, setting the stage posts at which decisions are taken and actually taking the decisions on whether to commit further resources to the project..." (para. 88).

"Just as with internally developed intangible property, the key question in determining economic ownership of acquired intangibles is where within the enterprise the significant people functions related to active decision-making relating to the taking on and management of risks are undertaken" (para. 94).

"The significant people functions relevant to the determination of economic ownership of [marketing intangibles such as brands]...include, for example, functions related to the creation and control over branding strategies, trademark and trade name protection, and maintenance of established marketing intangibles" (para. 97).

"The authorised OECD approach does not recognise dealings in respect of guarantee fees between the PE and its head office or between the PE and another PE" (para. 103).

"The consultation process has shown that there is an international consensus amongst governments and business on the principle that a PE should have sufficient 'free' capital to support the functions, assets and risks it assumes. However, the consultation process has also shown that it is not possible to develop a single internationally accepted approach for attributing the necessary 'free' capital" (para. 147).

Once the required funding of the PE and the portion thereof which is free capital is determined, "[t]he balance of the funding requirement is therefore the amount by reference to which the interest deduction is calculated...." (para. 150).

"Just as for capital attribution, it does not seem possible to develop a single approach for determining the amount of attributable interest expenses that could be applicable in all circumstances. Some countries favour a fungibility approach, whilst others want to retain tracing of funds for non-financial institutions...Other countries may want to use appropriately recognised 'treasury dealings' to reward a treasury function....Accordingly, all these approaches should be treated as authorised under the authorised OECD approach (para. 156)."

"Where the amount of free capital allotted by the enterprise is less than the arm's length amount as determined by one of the authorised approaches, an appropriate adjustment would need to be made to reduce the amount of interest expense claimed by the PE in order to reflect the amount of the enterprise's 'free' capital that is actually needed to support the activities of the PE. The adjustment will be made following the rules of the PE's host country, subject to Article 7" (para. 162).

"Any...domestic tax law requirement that provided for an amount of 'free' capital in excess of the arm's length range would be restricted by Article 7 to an amount that was within the limit set by the arm's length range" (para. 166).

"[U]ltimately it is the functional and factual analysis which determines whether the dealing [between the PE and the rest of the enterprise] has taken place, not the accounting records....This will require the determination of whether there has been any economically significant transfer of risk, responsibilities and benefits as a result of the 'dealing' (para. 177-178).

"[T]he authorised OECD approach treats 'dealings' as analogous to transactions between associated enterprises and so the guidance in paragraphs 1.52-1.54 of the [Transfer Pricing] Guidelines can be applied in the PE context by analogy" (para. 179).

D-3 Second step: determining the profits of the hypothesised separate and independent enterprise based upon a comparability analysis

"In the factual situation where the PE is regarded as becoming the economic owner of the tangible asset from that time forward, the fair market value of the asset at the time of transfer would generally provide the basis for computing an allowance for depreciation in the host country, subject to that country's domestic law" (para. 196).

"[I]n the context of the authorised OECD approach, the use of the word 'royalty' intended to refer to the arm's length compensation that one would have had to pay (and deduct from income) for the use of the intangible if the provider of the intangible were a separate and independent enterprise' (para. 201).

"In circumstances where an intangible developed by one part of the enterprise is to be further developed by the enterprise as a whole, it might be that such further development would be conducted in a cost contribution arrangement-style (CCA-type) activity in which the PE is a participant. In such circumstances the PE would be treated for tax purposes as if it had acquired an interest in the pre-existing intangible property (a buy-in) and any subsequent dealings related to the further development of the intangible property would be determined by following, by analogy, the guidance given in Chapter VIII of the [Transfer Pricing] Guidelines" (para. 211).

"[T]he degree of sophistication of the notional construct that is required by an economic CCA between parts of a single legal enterprise precludes claims that are not backed by convincing contemporaneous documentation" (para. 215).

D-5 Dependent agent PEs

"Issues arise as to whether there would remain any profits to be attributed to the dependent agent PE after an arm's length reward has been given to the dependent agent enterprise....However, the authorised OECD approach recognises that it is possible in appropriate circumstances for such profits to be attributed to the dependent agent PE" (para. 234).

Parts II, III and IV (banks, financial traders and insurance companies, respectively) not summarized.