The OECD Committee on Fiscal Affairs issued on 3 May 2007 a public discussion draft on the on the application and interpretation of Art. 24 (Non-discrimination) of the OECD Model Tax Convention. The discussion draft is a result of an initiative of OECD's working party on tax treaty issues (WP1), initiated in late 2004, to analyse technical issues concerning the application of Art. 24 and review broader policy issues. The discussion draft includes proposed amendments to the Commentaries to Art. 24. The contents of the discussion draft are summarized below.

General remarks concerning the scope of Art. 24

Several of the existing Commentaries on the articles of the OECD Model contain preliminary remarks. The discussion draft proposes to include general remarks before tackling each of six paragraphs of the non-discrimination clause. The proposed general remarks would clarify, for example, that the scope of Art. 24 does not cover the so-called indirect or covert discrimination and that Art. 24 cannot be interpreted as to require a most favourable nation treatment.

Specific issues concerning group of companies

According to the OECD, specific issues of group taxation potentially impact Paras. 1, 3 and 5 of Art. 24.

From a tax treaty perspective, an issue arises since Art. 24(3) could be interpreted to treat the failure to allow consolidation of the earnings/losses of a host permanent establishment (PE) with the result of other group enterprises in that host country as an instance of discrimination. On this particular issue, the OECD proposes to include a reference in the Commentary that Art. 24(3) does not require any extension to PEs of domestic group regimes which are restricted to resident companies. The technical justification given by the OECD rests on the fact that the PE non-discrimination clause only relates to the taxation on the PE itself, which excludes its application to rules that relate to groups of related companies, such as group consolidation, transfer of losses or tax-free assets between companies under the same common ownership.

As regards the application of the ownership non-discrimination clause (Para. 5), the discussion draft uses the same argument in order to clarify that Art. 24(5) is similarly restricted to the taxation of the enterprise itself and generally excludes issues related to the taxation of the group to which the enterprise belongs. The OECD leaves, however, the door open to reconsider in the future the situations where an extension of group regimes would be appropriate.

Finally, the discussion draft proposes to include an example preventing the accessibility to group taxation benefits to a dual resident company subject to limited taxation in the country where it requests to benefit from the group regime.

Issues related to the nationality non-discrimination clause (Art. 24(1))

The discussion draft analyses the question whether Art. 24(1) should apply to companies or if Paras. 3, 4 and 5 already provide companies with sufficient protection against discrimination. On this point, the OECD proposes to clarify, through the inclusion of examples, that resident and non-resident companies are not in the same circumstances, except where residence is totally irrelevant for purposes of the domestic rule under scrutiny.

The OECD also dealt with the uncertainty as to what are the relevant factors in determining whether taxpayers are in the same circumstances for purposes of Art. 24(1). On this point, the OECD, although pointing out that other proposed changes may already clarify the phrase "in the same circumstances", decided to include a reference in the Commentary that taxpayers with limited tax liability are usually not in the same circumstances as taxpayers with unlimited tax liability.

Discussion draft released: Revised Commentary on Art. 7 of OECD Model – details

The OECD Committee on Fiscal Affairs (CFA) issued on 10 April 2007 a discussion draft on a revised Commentary concerning Art. 7 (Business profits) of the OECD Model Tax Convention.

(a) Background. The discussion draft, which follows the release on 21 December 2006 of a revised Report on the Attribution of Profits to Permanent Establishments, is essentially designed to improve certainty on the interpretation of existing treaties based on the current text of Art. 7. The proposed Commentary incorporates several of the conclusions of the 2006 Report that according to the CFA, "would not conflict with previous versions of the Commentary". In order to provide further certainty on the attribution of profits to permanent establishments (PE), the CFA also decided to reflect the Report's conclusions in a new version of Art. 7. The new version of Art. 7 is only expected to be released for public comment in late 2007.

(b) Interpretation of Para. 1 of Art. 7. The current Commentary provides little guidance on how to interpret the term "profits of an enterprise", beyond rejecting of the force of attraction principle. Two broad interpretations of the term "profits of an enterprise" were developed in that regard, namely the "relevant business activity" and the "functionally separate entity" approach. The proposed Commentary states that Art. 7 should not be interpreted as restricting the amount of profit that can be attributed to a PE to the amount of profits of the enterprise as a whole. Under the proposed Commentary, the application of paragraph 2 may result in profits being attributed to a PE even though the enterprise as a whole has never made profits.

(c) Interpretation of Para. 2 of Art. 7. The proposed Commentary indicates that in order to attribute profits to a PE, it will be necessary to determine the profits that would have been realized if the PE had been a separate and distinct enterprise engaged in the same or similar conditions under the same or similar conditions and dealing wholly independently with the rest of the enterprise. This is achieved by using a two-step approach. The first step requires a functional and factual analysis, identifying the economically significant activities carried through the PE. The second step requires to determine the remuneration for such activities by applying by analogy the transfer pricing principles with reference to the functions performed, assets used, and risks assumed, by the enterprise through the PE and through the rest of the enterprise.

The proposed Commentary also points out that the same two-step approach should be used to attribute profits to a an Agency PE under Para. 5 of Art. 5.
(d) Interpretation of Para. 3 of Art. 7. With regards to expenses attributed to a PE, the proposed Commentary clarifies that Para. 3 only determines which expenses should be attributed to a PE for purposes of determining its profits. The proposed Commentary clearly refers that the issue of whether those expenses, once attributed to the PE, are deductible is a matter to be determined by domestic law of the PE State.

(e) Consistency between Paras. 2 and 3 of Art. 7. The proposed Commentary eliminates several of the existing exceptions to the arm's length principle laid down in the current Commentary. On the related issue of whether a PE may deduct its interest expense on intra-entity loans, the OECD maintains the ban on deductions for internal debts and receivables, with the exception of financial enterprises such as banks.

(f) Capital attribution and funding. The proposed Commentary considers that a PE would require certain amount of funding made up of "free capital" and interest-bearing debt in order to support the functions performed, assets used, and risks assumed. The proposed Commentary accepts however that different approaches for attributing "free" capital are capable of giving an arm's length result.

The proposed Commentary recognizes that the use of different capital attribution methods by the PE State and the Residence State of the enterprise may give rise to double taxation. In that regard, the proposed Commentary highlights that the OECD Member States agreed to grant double taxation relief for the amount of interest deducted (which is derived from the application of the capital attribution approach used in the PE State), if the following conditions are met:

-		the difference in capital attribution results from conflicting domestic laws regarding the chosen capital attribution method; and
-		the approach used to determine the attribution of the capital is accepted in the PE state and produces a result consistent with the arm's length principle in that particular case.