Do We Need 7(3)? History and Purpose of the Business Profits Deduction Rule in Tax Treaties

Abstract

The current rules in tax treaties for business profits of permanent establishments (PEs) have recently received their greatest alteration since they were created in the 1950s as a result of the Report on Attribution of Profits to Permanent Establishments representing over a decade of work by the OECD. One result is that the deduction rule has been deleted from the new business profits article in the 2010 version of the OECD Model. This chapter considers the history of the business profits deduction rule and, in that light, whether its purpose was to prevent certain kinds of covert discrimination against PEs or whether it was intended to operate as a qualification on the separate enterprise arm’s length principle for PEs. It is argued that at least one purpose of the rule was non-discrimination in addition to and independent of that principle. As the principle has not changed in any way relevant to this issue, it is suggested that the OECD should restore a version of the deduction rule to the Commentary as an option for countries with the kind of rules at which it seems to have been directed. The history makes evident, however, that the rule was one manifestation of other deeper issues as to the appropriate way in which to allocate profits to PEs and those issues remain unresolved.

Keywords: OECD, permanent establishment, business profits, international taxation, deductions, transfer pricing, treaties

JEL Classification: H25, K10, K30, K33, K34