Transfer pricing plays a key role when it comes to the allocation of Profits to Permanent Establishments. Tax authorities have shown increasing interest in foreign companies performing activities in their jurisdictions through PEs, therefore multinational enterprises should manage the existence and the allocation of income to PEs carefully. STI Taxand can assist in the preparation of transfer pricing analysis for the attribution of profits to PEs, by applying the general guidance on the attribution of profits to Personal Establishments and national requirements for PEs.

Profit attribution to PEs differs from standard Transfer Pricing between group entities, as it involves the allocation of profits between the PE (branch) and its Head Office, which are part of the same legal entity. Under acceptable international principles, profits are attributed to PEs based on Article 7 of the OECD Model on Income and on Capital, which provides that profits attributed to the PE are those it would make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing independently with the rest of the enterprise.

As the attribution of profits to PE is a matter that is yet to achieve international consensus there are three main methods that can be used to determine the arm’s length principle based on international guidance and national practices in different countries:

1. Branch accounting;
2. Agreed allocation formulas; and
3. The Authorised OECD Approach (AOA)

The AOA was the result of a decade-long project undertaken by the OECD to create the “preferred approach given modern day multinational operations and trade for the attribution of profits to permanent establishments, and it is applied based on the guidance provided by the report on the allocation of profits to PEs by the OECD published in 2010. Under step 1 of the AOA the PE is hypothesised to be a separate and independent enterprise through the functional and factual analysis which attributes to it functions, assets and risks based on the location of Significant People Functions. Then capital is allocated to the location which carries those functions, assets and risks as it has a supportive role. Then, the dealings between the PE and the other parts of the enterprise are determined, as if they were transactions between two independent enterprises. Step Two involves the comparability exercise where the Transfer Pricing Cyprus Guidelines are applied by analogy.

STI Taxand can assist you in preparing a transfer pricing analysis for the attribution of profits to PEs, following the acceptable method based on the regulatory framework that the client has to comply with and taking into account business-specific considerations.