The new "functionally separate entity" approach implemented by the OECD changed the previous business profit article as follows:
- It requires a much further/deeper separation of the PE from its head office; and
- The PE can now claim certain expenditure relating to notional interest, notional royalties/licences and mark ups on notional management fees, which it previously couldn't.
So how come the new "functionally separate entity" approach is not followed by all OECD member countries or UN countries? I am not certain as to why some countries have elected to not follow the new approach but the following is a plausible answer.
When creating/simulating a notional transaction in order to attribute profits to a PE this will create more expenditures than previously available. The creation of extra expenditure will result in less taxes payable by that PE within its tax jurisdiction. This in itself means that the countries who 'house' the PEs will be worse off than previously. Now one might argue - but what if I create a subsidiary, then all the expenses would also be deductible. That is correct, but with real transactions other taxes are applicable. For example a 'real' transaction involving interest payments usually triggers withholding taxes, a notional transaction will not trigger such a tax.
From the above it seems that tax jurisdictions which generally have more PEs, such as the UN countries would be worse off implementing the new "functionally separate entity" approach.
What are your thoughts on the above? Have you got another plausible answer?