How well do the income allocation rules work together after BEPS?

The OECD’s Base Erosion and Profit Shifting (BEPS) project made a number of very significant changes to the transfer pricing rules. These rules operate to regulate (by reference to the arm’s length principle) the pricing of transactions and arrangements between separate legal entities in the same multinational group. The effect of other changes made in the BEPS project has been to widen the circumstances in which one legal entity might be regarded as constituting a “permanent establishment” (in effect, a taxable branch) of another. The main consequence of such a determination is that the separate income allocation rules dealing with the attribution of income to permanent establishments (branches) would be triggered to calculate the amount of the profits that should be allocated to any such branch.

All of these changes raise the question of how the two sets of income allocation rules (the transfer pricing rules and the attribution rules) fit together. That is the question that is explored in this paper. Following the relevant BEPS changes, the interplay of these two sets of income allocation rules is technically very complex. Those provisions are especially relevant in the case of complex global business models and structures. The paper is particularly concerned with additional guidance that has been issued by the OECD on the topic in recent months.

The analysis concludes that a number of critical problems have not been considered by the further OECD guidance. For example, there are various problems relating to the treatment of risk that the new guidance simply ignores. The practical consequences of this situation are important, not least because of the need for clear and relevant OECD guidance as a mechanism to reduce cross border disputes.

Joseph Andrus and Richard Collier, “OECD Discussion Draft: additional guidance on the attribution of profits to permanent establishments”, [2017] British Tax Review, No. 5, 509.