Official publication of the Kingdom of the Netherlands since 1814.

No. 16683 1 July 2022

STAATSCOURANT

International Tax Law. Winstallation of permanent establishments

Directorate-General for Fiscal Affairs, Directorate for Consumption Taxes, Customs and International Affairs

Decision of 14 June 2022, No 2022-0000143421, Government Gazette 2022, No 16683 The State Secretary for Finance has decided the following.

This decree provides further insight into my views on profit allocation to permanent establishments. The purpose of this decree is to clarify how the Inland Revenue assesses profit allocation to permanent establishments.

Developments in the field of profit allocation to permanent establishments, including the results of the OECD's BEPS1 project, prompt an update of the Decree of

15 January 2011, no IFZ 2010/457M. This decree addresses the introduction of the object exemption in the 1969 Corporate Income Tax Act (Wet Vpb 1969) in 2012, makes a number of editorial changes and updates references to other decrees and documents.

1. Introduction

1.1 Abbreviations and terms used

AOA Authorised OECD Approach

Article 7 New The Article 7 OECD Model Convention adopted in July 2010

Article 7 Old The Article 7 OECD Model Treaty applicable until July 2010

BEPS Base Erosion and Profit Shifting

Bvdb Double Taxation Avoidance Decree 2001

KERT functions Key Entrepreneurial Risk Taking functions

OECD Organisation for Economic Cooperation and Development

OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations

PE Permanent Establishment

PE-Report Report on the Attribution of Profits to Permanent Establishments 2010

Corporate Income Tax Act 1969

1.2 Purpose of the decree

The purpose of this decree is to provide clarity on how the Tax Administration assesses the attribution of profits to permanent establishments. Accordingly, this decree provides further insight into the Dutch positions on profit allocation to permanent establishments. These views relate only to the allocation of profit-based income and expenses and not to the taxability and deductibility of these individual income and expenses.

The views are also relevant to the application of Article 15 of the 1969 Corporate Income Tax Act and the 1965 Dividend Tax Act with respect to the allocation of shares to a permanent establishment located in the Netherlands.

This decision does not concern the application of Article 5 OECD Model Convention in the question of whether there is a permanent establishment and does not concern Article 9 OECD Model Convention in the question of whether affiliated parties acted at arm's length.

1.3 Outline of Dutch policy

Alignment with the PE Report

The Dutch policy on profit allocation to fixed directions is in line with the conclusions of the PE Report.2 The PE Report opts for the 'functionally separate entity approach' and thus for the application of the arm's-length principle as further elaborated in the OECD guidelines.

The starting point for profit allocation in the PE Report is the 'Authorised OECD Approach' (AOA). Briefly, the AOA consists of the following steps:

1. In the first step, assets and risks as well as capital are allocated to the PE based on the functional analysis. In this asset allocation, two methods can be broadly distinguished: the capital allocation approach and the thin capitalisation approach. Partly in view of the premise of the PE Report that, in principle, the permanent establishment has an equal credit rating as the entity as a whole, I prefer the capital allocation approach.

2. In the second step, the profit of the permanent establishment is determined based on the analysis in the first step and the application of the arm's-length principle. Thereby, the interest expense in respect of the allocated loan capital can be determined using two methods: the fungibility approach and the tracing approach. I prefer the fungibility approach, whereby after the allocation of capital based on the capital allocation approach, the interest expense of the entity is allocated to the permanent establishment in proportion to the allocated loan capital.

The object exemption

With effect from 1 January 2012, the object exemption was introduced for (foreign) permanent establishments in the 1969 Corporate Income Tax Act by means of Section 15e of the 1969 Corporate Income Tax Act.3 From the introduction of the object exemption for foreign corporate profits, both the positive and negative results of the foreign permanent establishment are eliminated from the worldwide profits of a Dutch entity.4

For profit allocation to permanent establishments in treaty situations, the applicable treaty article is relevant. For profit allocation to permanent establishments in non-treaty situations, the most recent text of Article 7 OECD Model Convention should be followed,5 making the OECD commentary on this article and the PE Report relevant.

Article 7 OECD model treaty

In the Netherlands, when interpreting treaties entered into before amendments to the OECD commentary on the relevant article, the aim is to achieve an outcome that is as close as possible to the most recent understanding in relation to the arm's-length principle. As a result, amendments intended as clarification also apply to treaties concluded before amendment of the commentary. The amendments to the Commentary on Article 7 as adopted in July 2008 are such clarifications. They therefore apply to existing treaties. However, it is not the case that the amendments to Article 7 New and its commentary automatically carry over to existing treaties concluded with a different Article 7.

The question to what extent the amendments to Article 7 New and its commentary affect the application of treaties with the old text is not easy to answer. However, it is undesirable for implementation practice if there is uncertainty about this. To avoid this uncertainty, I am prepared to apply all the principles of the PE Report also to treaties containing the text of Article 7 Old. Therefore, the Tax Administration will not correct an arm's-length profit attribution to a permanent establishment that is based on the principles of the PE Report and as such has also been consistently applied by taxpayer in the other country concerned. This also applies to the exemption of foreign profits under Section 15e of the 1969 Corporate Income Tax Act or to the taxation of foreign taxpayers in situations where no tax treaty applies.

In addition, it is relevant that the PE Report, the relevant articles in the OECD Model Treaty and the accompanying commentary have no direct significance for the application of domestic tax laws and of the CoC, but only for the interpretation of tax treaties concluded by the Netherlands. However, the provisions on permanent establishments in the national tax laws, in the Covdb and in the bilateral treaties do share the same principles. This is reflected in the very similar definitions of a permanent establishment and the method by which profits should be attributed to a permanent establishment. Diverging interpretations of these provisions could lead to double taxation or double non-taxation and that would be contrary to the purpose of these regimes.

Double non-taxation

The Dutch principle is that double non-taxation resulting from a different interpretation of the arm's-length principle in the allocation of profits in relation to a tax levied on profits is undesirable and should be avoided as much as possible. If and to the extent that a taxpayer makes different choices when allocating profits in the countries concerned that result in part of the profits of the permanent establishment not being included in the levy of a tax levied on profits, the Tax Administration may deviate from the policy described in this decree in order to arrive at an outcome that does not result in double non-taxation.

2. Settlement of profits of permanent establishments

2.1 General

The PE-Report was published in July 2008 and updated in 2010.67 This report describes how profits8 should be allocated to permanent establishments. The purpose of the PE Report is to achieve greater international consensus on the application of Article 7 OECD Model Convention. Although the Article 7 in force in 2008 included the reference to the functionally separate entity approach as such in paragraph 2, from experience in practice further clarification proved necessary. In addition, new insights on profit allocation to permanent establishments were incorporated in the PE Report.

In implementing the PE Report, the OECD followed a two-step process. To the extent that the conclusions of the PE Report did not conflict with the commentary existing at the time, the commentary on Article 7 OECD Model Convention was amended in 2008. This mostly involved clarification or further interpretation. The second step in the implementation process was to rewrite the existing Article 7 OECD Model Convention and Commentary. This was adopted by the OECD in July 2010.

The starting point for profit allocation in the PE Report is the AOA. Under this approach, a PE should be allocated the profit that would have been earned by the PE if it had been a separate unaffiliated entity with similar functions, risks and assets, acting under the same or similar circumstances. The PE Report refers to this approach as the functionally separate entity approach. The rationale behind this approach is that the determination of profits of permanent establishments should be based on the arm's-length principle as it applies to affiliated entities under Article 9 OECD Model Convention and is further elaborated in the OECD Commentary to this Article and in the OECD Guidelines. An important difference in the application of the arm's-length principle based on Article 7 OECD Model Convention compared to the application based on Article 9 OECD Model Convention is the absence of legally binding contracts between a permanent establishment and a principal house.

2.2 Authorised OECD Approach

The AOA consists of two steps:

1. In the first step, assets and risks as well as capital are allocated to the permanent establishment based on the functional analysis.

2. In the second step, the profit of the permanent establishment is determined based on the analysis in the first step and the application of the arm's-length principle.

2.2.1. Step 1. Allocation of assets and risks based on the functional analysis

In the first step, the allocation of assets and risks should generally follow where the so-called 'significant people functions' are performed. Significant people functions are related to the people performing the activities related to asset ownership and risk taking and management. These are the so-called 'day to day' activities that play a defining role in business operations. The location of these activities determines the allocation of economic ownership of assets and risks assumed by the entity.

Also, in the first step, equity and then debt capital are allocated to the permanent establishment. The basic principle here is that a permanent establishment should be allocated sufficient equity in relation to the activities, assets and risks allocated to it. The allocation of equity therefore takes place after the allocation of assets and risks on the basis of a functional analysis. The assumption here is that the permanent establishment has equal credit worthiness as the entity as a whole.

For the allocation of equity to the permanent establishment, the PE Report describes several methods that can lead to different outcomes, namely:

1. Capital allocation approach, this method assumes the current capital structure of the general body; and

2. Thin capitalisation approach, this method assumes the capital structure of unrelated entities comparable to the permanent establishment.

Dutch policy aims at an attribution of profit to the permanent establishment that leads as much as possible to the profit an unaffiliated entity would have achieved with similar activities under similar circumstances. In this context, I prefer the capital allocation approach, partly in view of the PE Report's premise that, in principle, the permanent establishment has an equal creditworthiness as the entity as a whole.

To achieve equal creditworthiness, both the value of assets and the risks associated with the activities and assets will have to be considered when allocating capital.

An example of the application of the capital allocation approach is detailed in an annex to this decision.

The PE Report outlines at the first step of the AOA under what circumstances dealings between the main house and the permanent establishment should be assumed. These dealings affect the profit allocation between head house and permanent establishment. Specific dealings relating to group services, intangible assets and financing are discussed in more detail in paragraph 4 of this decision.

With regard to the allocation of equity and debt, the following also applies:

- In principle, the determination of the value of assets when determining the relative importance of the asset side of the permanent establishment in relation to the balance sheet of the entity as a whole will have to be based on the fair value of the assets.

- In principle, the determination of the relative value of assets should be determined annually.

- In view of the complexity of determining the annual relative value of assets and the realisation that the allocation of equity and debt is not an exact science, the Tax Authorities will allow some flexibility in their assessment.

2.2.2 Step 2. Allocation of costs and revenues based on the arm's-length principle

In the second step, costs and revenues are allocated at arm's length to the permanent establishment based on the functions, assets, risks, assets and dealings as analysed in the first step. For the dealings identified in the first step, a transfer price should be determined in the second step.

After allocating equity and debt, an arm's-length interest charge should be allocated to the PE. The PE Report describes two methods for this purpose:

1. The tracing approach, whereby the interest rate is determined as close as possible to the interest rate of the external loan raised to finance the specific asset; and

2. The fungibility approach, in which the total interest expense of the entity as a whole is allocated to the permanent establishment in proportion to the allocated loan capital and the historical connection with a loan is not important.

2.2.3 Dutch preferred method of interest expense allocation

The premise of the AOA is that the permanent establishment has the same creditworthiness as the general body. There can be no internal guarantee and there is limited freedom of choice in the allocation of equity and debt to the permanent establishment.

I prefer the fungibility approach. After all, the tracing approach takes less account of the specific circumstances of the permanent establishment and may therefore not lead to the attribution of an arm's-length interest expense to the permanent establishment.9 Under the fungibility approach, however, this can be taken into account if, based on the functional analysis, a pro rata portion of the interest expense of the entire entity is attributed to the permanent establishment. Under such a method, the size of the interest expense is expected to approximate the interest expense that an unaffiliated lender would charge when financing a similar unaffiliated entity. Indeed, the premise of the AOA is that the deductible interest expense of the permanent establishment should not exceed an interest expense that is arm's length.

As the capital allocation approach in combination with the fungibility approach is most in line with the principle of equal creditworthiness, the Tax Authorities will in principle use the capital allocation approach for the attribution of equity to the permanent establishment and the fungibility approach for the attribution of interest expense in its assessment.

Only if the general body is not financed in accordance with the arm's-length principle, resulting, for example, in too little equity and too high interest expenses being allocated to the permanent establishment, will the Tax Administration abandon this approach. Then the external comparison-based thin capitalisation approach may be used. In that case, in order to still be able to determine an arm's-length profit of the permanent establishment, the size of the permanent establishment's equity and the size of its interest expenses will be compared to unrelated entities similar to the permanent establishment.

An example of the application of the fungibility approach is detailed in an annex to this decision.

2.3 The use of different methods in the country of the principal residence and permanent establishment

Because no specific method is chosen in the PE Report, there is a risk that countries may take a different approach to the allocation of equity and interest expense, resulting in no or double taxation.10 If, due to the application of a different ben- ficiality with regard to the allocation of interest expenses by different tax authorities, taxpayer faces double taxation, I am willing to enter into consultations with the competent authority of the other country when applying a tax treaty, striving to eliminate the resulting double taxation as described in Decision of 11 June 2020, no. 2020-0000101607, Government Gazette 2020, 32689.

When applying treaties in which Article 7 Old applies, in accordance with the commentary in paragraph 48 to that Article, when using a different approach with respect to asset allocation in the relevant countries, the approach of the country of the permanent establishment will be followed if:

1. the different approaches in the countries result from choices embedded in laws or regulations; and

2. the choice in the country of the permanent establishment is an OECD-authorised choice; and

3. in the particular case under consideration, this approach results in a result that can be considered arm's length.

As also noted in paragraph 1.3 of this decision, the Tax Administration may deviate from the policy in this decision to arrive at an outcome that is arm's-length and that does not result in double non-taxation.

3. Risk allocation, significant people functions versus control

It is important that the assumptions used for risk allocation as part of the profit determination of a permanent establishment are as similar as possible to the assumptions used for risk allocation in transactions between related entities. In that context, the concepts of significant people functions and control are important.

The PE Report introduced the concept of significant people functions in the analogous application of the arm's-length principle for profit allocation to permanent establishments. Signifi- cant people functions are those that involve actively making decisions relating to the ownership of assets and the assumption and management of risk. According to the PE-Report, this refers in particular to the day-to-day activities that play a determining role in a body's operations.

The section of the PE Report dealing with financial institutions uses the term 'key entrepreneurial risk-taking' functions (KERT functions) for this purpose. The reason for using this different terminology lies in the fact that in financial institutions, more than in other entities, there will be an overlap between the significant people functions that determine the attribution of economic ownership of assets and the significant people functions in assuming and managing risk. This is due to the close relationship at financial institutions between assets and risks. A KERT function at a financial institution usually refers to an activity (significant people function) that is important both for the attribution of an asset and for the attribution of a risk (e.g. the granting of a loan by a bank).11

The OECD Guidelines, which elaborate on the arm's-length principle in relation to transactions between related entities, also address risk allocation. Although in the OECD guidelines the contractual reality is the starting point of the functional analysis, attention is also paid to how risks are allocated between parties. In the OECD guidelines, the concept of control plays an important role in risk allocation. This is defined as follows: 'Control over risk involves ({) (i) the capability to make decisions to take on, lay off, or decline a risk-bearing opportunity, together with the actual performance of that decision-making function and (ii) the capability to make decisions on whether and how to respond to the risks associated with the opportunity, together with the actual performance of that decision-making function.'12

Paragraph 1.65 of the OECD Guidelines thereby states at the end that for the allocation of risks, 'a party requires both capability and functional performance as described above in order to exercise control over a risk'.

The question is what exactly is the relationship between the significant people functions and the functions of people exercising control in relation to certain risks. The activities of the parties exercising control could have a slightly different character from the activities of the parties exercising the significant people functions, in that they may be functionally somewhat further removed from the day-to-day activities.

As the starting point of the PE Report is to align the AOA in respect of permanent establishments with the arm's-length principle as much as possible, I assume that, although these concepts could possibly be interpreted differently in the elaboration, a large overlap can be recognised in the activities of parties exercising control over the risks (in the context of Article 9 OECD Model Convention) and the day-to-day activities of the significant people functions (in the context of Article 7 OECD Model Convention). See also the examples in the Transfer Pricing Decision13 regarding the role of the principal in relation to the performance of research activities.

4. Dealings

Dealings are defined in the PE report as transactions between the permanent establishment and other parts of the entity to which the permanent establishment belongs, as equivalent to transactions between unrelated entities.

4.1 Concern services

Based on the arm's-length principle, intra-group services should be remunerated as they would have been under similar circumstances between unrelated entities. The PE Report is entirely consistent with this approach.

The third paragraph of Article 7 Old provides rules for costs deductible at the permanent establishment. According to this article, executive and general management expenses are among the deductible expenses, regardless of where these expenses were incurred. This should not be read in this context as a limitation of the second paragraph of Article 7 Old, but as a clarification that does not prevent the application of the arm's-length principle.

Although the third paragraph of Article 7 Old does not preclude an approach based on the arm's-length principle, the commentary to Article 7 Old (paragraphs 37 and 38) states that, for the services mentioned there (including strategic management), costs are allocated without taking into account a profit mark-up.14 This is different only if the services in question are also provided more than incidentally to unrelated parties or if the services in question constitute the main activity of the entity (paragraphs 35 and 36). It is my view that in the case of in-house services, as with the application of Article 9 OECD Model Convention, a profit mark-up should in principle be taken into account to arrive at an arm's length outcome.

I will take a flexible approach when applying treaties not based on Article 7 New when interpreting Article 7 Old. Specifically, this means that with regard to the services mentioned in the commentary, the allocation of costs to a permanent establishment both on the basis of all relevant actual costs without mark-up and at a price based on the arm's-length principle will in principle be considered appropriate.

With the introduction of Section 7 New, there can no longer be any doubt about the application of the arm's-length principle in fictitious intra-group services.

For determining the transfer price for a intra-group service, see section 6 of the Transfer Pricing Decree.15

4.2 Intangible fixed assets

Paragraph 34 of the commentary to Article 7 Old has often been incorrectly interpreted in the past as prohibiting the calculation of internal notional royalty fees between the principal house and the permanent establishment. The paragraph outlines the complexity of allocating intangible fixed assets to part of an entity. Based on this observation, the commen- tary therefore suggests that the cost should be allocated (without profit mark-up) between main house and permanent establishment. If it is made plausible that the costs of developing the intangible fixed assets are attributable to only one part of the entity, I believe there is scope for charging a royalty.

It is my starting point to use a system that leads to an outcome equal to the outcome in comparable situations in unrelated entities as far as possible. For both the allocation of self-developed and purchased intangible fixed assets, it is decisive which part of the entity, based on the significant people functions, takes the active decisions with regard to entering into and managing the risks related to the intangible fixed assets.

Mere cost sharing is not appropriate if, based on the facts and circumstances, a system based on the arm's-length principle is among the possibilities and leads to a different outcome.

4.3 Financial transactions

According to the commentary to Article 7 Old (paragraphs 41 and 42), internal notional interest is generally (with the exception of financial institutions such as banks) prohibited. The allocation of equity and debt capital to the permanent establishment is based on the desire to achieve a capital structure based as far as possible on the arm's-length principle. The allocation of equity (equity and debt) takes place after the allocation of assets and risks based on the functional analysis. The resulting attributable loan capital and the associated interest expense for the permanent establishment is also a determinant of profit allocation.16

Although, given the way of allocating equity and debt to the permanent establishment as described in the PE Report, there seems to be little room for internal interest to be taken into account, the explicit prohibition of internal interest is no longer described and no longer plays a role in the commentary to Article 7 New.

According to the PE-Report, internal interest payments can only occur if and to the extent that there are treasury activities that qualify as significant people functions and which, based on the functional analysis, justify an arm's-length remuneration related to the cash flows and risks involved. According to the PE Report, these interest payments only have implications for the remuneration of the treasury function and not for the allocation of the amount of equity and debt given that this allocation is made on the basis of one of the methods described in the PE Report.

A situation where the permanent establishment is allocated more loan capital than actually borrowed by the entity from external parties (affiliated or unaffiliated) does not fit into the approach I advocate. This is because, in principle, based on the capital allocation approach, a share of first the equity and then the loan capital of the entity should be allocated to the permanent establishment, on the one hand, and the permanent establishment should have the same creditworthiness as the general body, on the other. The existence of a treasury function cannot lead to the allocation of an interest expense in relation to a loan that is not from external parties (affiliated or unaffiliated).17 These principles apply to both financial and non-financial institutions.

The existence of a treasury function does not automatically lead to interest payments. Indeed, depending on the specific facts and circumstances as identified in the functional analysis, remuneration for the treasury function can also be shaped by means of a notional pass-through of costs with an appropriate profit mark-up.

With the PE Report highlighting the importance of the self-employment fiction, there may be discussion as to whether, depending on the specific facts and circumstances, an interest expense or interest income on an internal debt or receivable resulting from supplies of goods and/or services can be taken into account. Given the approach adopted in the PE Report to allocate equity and debt based on one of the methods described, it is not obvious to consider an interest expense or interest income related to amounts owed as a result of internal supplies or services in addition to calculating interest expense based on one of these methods. The interest expense or interest income resulting in unrelated proportions from such transactions is implicitly part of the interest expense or interest income calculated on the basis of the capital allocation method used when allocating profits of a permanent establishment.

5. Specific topics

5.1 Tangible fixed assets

It is not possible to attribute assets to the PE on the basis of legal ownership. Therefore, the PE Report seeks analogy with the concept of economic ownership in paragraphs 72 to 74, Part I (2010 version). Decisive here are again the significant people functions as revealed by the functional analysis. In practice, when allocating property, plant and equipment, discussions sometimes arose as to whether the significant people functions or the place of use should be decisive for economic ownership. With effect from 2008, the

OECD Commentary (by referring to sections D-2 and D-3 of Part I of the PE Report) opts for the attribution of property, plant and equipment to the permanent establishment if it is used there (place of use), unless special circumstances justify a different approach.

In the Netherlands, the Supreme Court has long distinguished between permanent and temporary availability to the permanent establishment. If the permanent establishment is made available on a permanent basis, the permanent establishment is considered the economic owner of the tangible fixed assets. If it is only temporarily made available, the permanent establishment should be regarded as the lessee of the asset and the main establishment as the lessor (see BNB 1986/100). I mark the temporary disposal as a special circumstance that justifies a different approach from the place of use approach as defined in the OECD Commentary.

5.2 Financial assets

Also for financial assets (such as cash and receivables), economic ownership is allocated to the permanent establishment if the significant people functions relating to the assumption and management of the risks in respect of these assets are exercised by the permanent establishment.

An exception to this allocation rule may apply to financial assets held for a specific purpose, such as a planned acquisition or a planned dividend distribution. In that case, these assets should not be allocated to the permanent establishment if the decision has not been taken there to use these funds for this purpose.

5.3 The agent as permanent representative

The PE Report (see D5 of Part I) describes how profits should be allocated to a specific permanent establishment, being the permanent establishment of the foreign principal resulting from the designation of a dependent agent, whether affiliated or not, as a permanent representative. In fact, two taxpayers arise in that situation: the company of the dependent agent (the 'dependent agent') and the permanent establishment of the foreign principal (the 'dependent agent PE'). With emphasis, the methodology described does not apply to determine whether there is a dependent agent. As regards the allocation of profits, according to the PE Report, the same rules apply to the dependent agent PE as to an ordinary permanent establishment.18

I am of the opinion that, given the premise that the agent should be remunerated at arm's length in the conduct of its own business, there is normally no reason to additionally allocate profits to any permanent establishment of the foreign principal to be determined.

If the foreign principal carries out significant people functions with its own personnel through a permanent establishment, profit should be allocated to it.

5.4 Certainty in advance

For obtaining advance certainty on the allocation of profit to a permanent establishment, see the Decree of 9 August 2021, No 2021/16465, Government Gazette 2021, 38442.

6. Entry into force

This Decree shall enter into force as of the day after the date of issue of the Government Gazette in which it is published.

7. Repealed decree

The following decree has been repealed with effect from the entry into force of this decree:

- Decree of the State Secretary of Finance of 15 January 2011, no. IFZ2010/457M, Government Gazette 2011, 1375.

8. Citation title

This decree shall be cited as: Decree on Profit Allocation of Permanent Establishments 2022. This decree will be published in the Government Gazette.

The Hague, 14 June 2022

The State Secretary for Finance,

M.L.A. van Rij

1 Base Erosion and Profit Shifting.

2 OECD (2010). 2010 Report on the Attribution of Profits to Permanent Establishments. OECD Publishing: Paris.

3 For permanent establishments in the Netherlands of a foreign entity, Chapter III (art. 17 et seq.) of the 1969 Vpb Act applies.

4 This does not apply to the low-taxed foreign investment company (Art. 15e(7) jo. Art. 15g Vpb 1969 Act).

5 In this decree, the new Article 7 OECD Model Convention as adopted by the OECD in July 2010 will be referred to as Article 7 New. The Article 7 that was valid until July 2010 will be referred to in this decree as Article 7 Old.

6 The main purpose of these adjustments was to align certain terms in the PE Report with terms in the new Article 7 OECD Model Convention and the updated OECD Guidelines. No substantive changes were intended with these adjustments.

7 Following the publication of the PE Report, the OECD published the Additional Guidance on the Attribution of Profits to a Permanent Establishment under BEPS Action 7 in March 2018. This report does not deviate from the Dutch view based on the PE-Report.

8 Where this decision refers to the term profits, this also includes losses.

9 Specific circumstances here refers to the functions, assets and risks of the permanent establishment.

10 See Section 12aa (1) (g) of the 1969 Vpb Act where a possible mismatch may arise with regard to interest allocation due to a different approach of tax authorities with regard to the allocation method of equity and debt capital and of interest expenses, which may result in double deduction.

11 Regarding specific considerations for profit allocation to a permanent establishment in the case of financial institutions and financing transactions, I refer to the second part (Part II. Banks) of the 2010 PE Report.

12 OESO (2022). Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, para 1.65.

13 Decision of the Secretary of State for Finance, No 2022-0000139020.

14 The Article 7 Old commentary here refers to the commentary on the OECD Model Convention revised in 2008.

15 Decision of the Secretary of State for Finance No 2022-0000139020.

16 It is known that in practice, banks often have their own internal funds transfer pricing system. The fact that many banks use such a system is also recognised in the PE Report. The report stresses that it is important that such a system results in an allocation of interest expenses that is consistent with the arm's-length principle. Paragraph 169 of Part 2 of the PE Report states that where funds transfer pricing systems assume 100% debt financing, an adjustment will need to be made to accommodate the principle that a permanent establishment should be allocated sufficient equity to support its allocated activities, assets and risks. The same paragraph additionally recognises that it may also be necessary to make an adjustment for more expensive forms of debt capital of the bank if they are not adequately translated into the funds transfer pricing system.

17 See also paragraphs 157 and 158, Part I of the PE Report (2010 version).

18 The definition of dependent agent PE has been updated in the OECD Report 'Additional Guidance on the Attribution of Profits to Permanent Establishments, BEPS Action 7' published in 2018.

ANNEX TO PROFIT ALLOCATION DECISION PERMANENT ESTABLISHMENTS

Example relating to the elaboration of the capital allocation approach and fungibility approach

This example is included to illustrate the capital allocation approach and fungibility approach. The purpose of the method used is to allocate equity and then debt capital to the permanent establishment.

The general body has the following balance sheet:

Assets should be allocated to the permanent establishment under the first step of the AOA. Suppose that based on the significant people functions analysis, the allocation of assets to the permanent establishment results in assets in the amount of 200. In that case, financing in the amount of 200 should then be allocated to the permanent establishment. The question is what part of that should be equity and what part should be debt to determine the arm's-length interest expense of the permanent establishment.

In working out this example, a distinction is made between two situations. In both situations, it may be assumed that the permanent establishment has the same creditworthiness as the general body.

Situation 1:

This example assumes that the activities performed, assets used and risks incurred by the permanent establishment are fully comparable to those of the general body. Application of the capital allocation approach could then lead to equity having to be allocated to the permanent establishment in proportion to the value of the assets (in this case 200/400 * 150 = 75). The loan capital to be allocated in that case is 125 (200 - 75).

The balance sheet of the permanent establishment will then look as follows.

The interest expense will be calculated in proportion to the attributable loan capital of 125. Since the activities performed and assets used by the permanent establishment have the same risk profile as those of the general body, it is obvious that when applying the fungibility approach, around 50% of the interest expense of the body should also be attributed to the permanent establishment.

Situation 2:

This example assumes that the activities performed and assets used by the permanent establishment have a lower risk profile than those of the general body. Assume that application of the capital allocation approach leads to the conclusion that 1/3 of the body's equity

should be allocated to the permanent establishment, then an equity of 50 (1/3 * 150) should be allocated to the permanent establishment. As a result, the attributable portion of loan capital becomes 150 (200 - 50).

The balance sheet of the permanent establishment will then look as follows.

Because the permanent establishment has a lower risk profile than the general body, relatively less equity should be attributed to the permanent establishment in situation 2 and therefore also less than in situation 1. The downside of this is that relatively more loan capital should be attributed to the permanent establishment, so that in principle relatively more interest is allocated to the permanent establishment.