Attribution of Profits to Permanent Establishments: Implementation of the AOA in Germany and Abroad

Dou­ble ta­xa­tion trea­ties ge­ne­rally sti­pu­late that an en­ter­prise's pro­fits at­tri­bu­ta­ble to a for­eign per­ma­nent es­ta­blish­ment may only be ta­xed in the state in which the per­ma­nent es­ta­blish­ment is si­tua­ted. How the pro­fit at­tri­bu­ta­ble to the per­ma­nent es­ta­blish­ment should be de­ter­mi­ned is the fo­cus of a long-stan­ding dis­cus­sion not yet re­sol­ved to this day. The Or­ga­ni­sa­tion for Eco­no­mic Co-ope­ra­tion and De­ve­lop­ment (OECD) aims to bring cla­rity to this is­sue with its "Aut­ho­ri­sed OECD Ap­proach," known as the AOA, which was trans­po­sed into na­tio­nal law in Ger­many by the Act Im­ple­men­ting the Mu­tual As­sis­tance Di­rec­tive and Amen­ding Tax Re­gu­la­ti­ons (Amts­hil­fe­richt­li­nien-Um­set­zungs­ge­setz) ef­fec­tive 1 Ja­nu­ary 2013.

The fol­lo­wing sim­pli­fied ex­am­ples il­lus­trate how ap­ply­ing the AOA can af­fect the at­tri­bu­tion of pro­fits to a per­ma­nent es­ta­blish­ment ac­cor­ding to Ger­man law.

• The do­mestic per­ma­nent es­ta­blish­ment of a head of­fice re­si­dent ab­road de­ve­lops new pro­ducts for the head of­fice. Pre­viously, when cal­cu­la­ting the pro­fits of the do­mestic per­ma­nent es­ta­blish­ment, the ex­pen­ses ac­tually in­cur­red as a re­sult of these de­ve­lop­ment ac­tivi­ties were at­tri­bu­ta­ble to the per­ma­nent es­ta­blish­ment. Un­der the AOA, a ser­vice re­la­ti­ons­hip as bet­ween un­re­la­ted third par­ties is hy­po­the­si­zed bet­ween the head of­fice and the per­ma­nent es­ta­blish­ment and, ac­cor­din­gly, arm's length con­di­ti­ons are ap­plied. The per­ma­nent es­ta­blish­ment thus does not con­duct the de­ve­lop­ment ac­tivi­ties me­rely in re­turn for reim­bur­se­ment of the ex­pen­ses in­cur­red due to the ac­tivi­ties. In­stead, a com­pen­sa­tion pay­ment must be cal­cu­la­ted in line with the arm's length prin­ci­ple.
• A do­mestic head of­fice ac­qui­res li­cen­ses for con­trol­ling soft­ware. This soft­ware is used in both the head of­fice and in the per­ma­nent es­ta­blish­ment ab­road, which in turn per­forms con­trol­ling ser­vices for ano­ther sub­si­di­ary re­si­dent ab­road. To date, the li­cense fees were re­qui­red to be di­vi­ded bet­ween the head of­fice and the per­ma­nent es­ta­blish­ment in ac­cor­dance with their use of the soft­ware. Since the AOA re­qui­res the fic­tion of a ser­vice re­la­ti­ons­hip, an arm's length com­pen­sa­tion pay­ment must be cal­cu­la­ted equal to that which the per­ma­nent es­ta­blish­ment would pay an un­re­la­ted third party for the li­cense. At the same time, arm's length com­pen­sa­tion must be at­tri­bu­ted to the per­ma­nent es­ta­blish­ment for the ser­vices it per­forms for the sub­si­di­ary.

The ta­xable pro­fit of the head of­fice and the per­ma­nent es­ta­blish­ment chan­ges as a rule when the AOA is ap­plied. By ex­ten­sion, this im­pacts the en­ter­prise's tax rate. In cer­tain ca­ses, the hy­po­the­si­zed ser­vice re­la­ti­ons­hip bet­ween the head of­fice and the per­ma­nent es­ta­blish­ment can even re­sult in the as­sump­tion of fic­ti­tious pro­fits at­tri­bu­ta­ble to the per­ma­nent es­ta­blish­ment if the ser­vices pro­vi­ded by the per­ma­nent es­ta­blish­ment do not af­fect the en­ter­prise's ex­ter­nal pro­fits. Its tax lia­bi­lity would rise as a re­sult.

Eb­ner Stolz has laun­ched a sur­vey in coope­ra­tion with a num­ber of other mem­bers of the in­ter­na­tio­nal con­sul­ting net­work Ne­xia to de­ter­mine the ex­tent to which the AOA has al­re­ady been im­ple­men­ted in other coun­tries. The re­sults have been sum­ma­ri­zed in a re­port which pro­vi­des an in­itial pic­ture of the ef­fects of the AOA on the at­tri­bu­tion of pro­fits to per­ma­nent es­ta­blish­ments in these coun­tries and in­di­ca­tes whe­ther clas­si­fi­ca­tion con­flicts can be ex­pec­ted with the other state in­vol­ved.

The study can be down­loa­ded here.

Nexia Survey