The Article requires that the profits which are attributed to
the permanent establishment are those which it would be expected to
make if the permanent establishment was dealing at arm's length
with the enterprise of which it is a permanent establishment. This
includes dealings with the enterprise's other permanent
establishments and its associated companies and their permanent
establishments.
ICTA88/S28AA (ICTA88/S770 for accounting periods ending on
or before 30 June 1999) does not apply to transactions between a
permanent establishment of a non-resident enterprise and the
enterprise itself, (see IM4655 and IM4659(h)). Where goods are
transferred between head office and the permanent establishment or
services are provided by head office or vice versa the costs or
income attributable to the establishment must be arrived at on the
arm's length principle. This may require a price to be attributed
in the case of transfer of stock or merely a division of costs in
the case of certain services such as head office management
services. The Commentary on Article 7 of the OECD Model agreement
comments on this. Where an Inspector considers that the
transactions between the permanent establishment and the enterprise
may not be on an arm's length basis, the instructions at IM4650
onwards give some guidance as to how an arm's length basis can be
established. You should bear in mind, however, that the country of
which the non-resident enterprise is a resident may be a high tax
country so that there may be little or no benefit to the enterprise
in having transactions with its permanent establishment not on an
arm's length basis unless the country in question offers special
incentives or reduced rates of tax to certain classes of taxpayer
or the enterprise as a whole is making a loss.
Although the United Kingdom is in all cases entitled to its
proper share of the enterprise's total tax liability, Inspectors
should not enter into lengthy discussions about the basis on which
the profits of the United Kingdom permanent establishment have been
arrived at, unless there are substantial amounts involved and there
is prima facie evidence of transactions not being at arm's length.
In such cases, once the main facts have been established, but
before any detailed enquiries are started, refer the case to
International Division, Melbourne House.
Where the United Kingdom branch or agency is a branch or
agency of a resident of a country with which the United Kingdom has
no double taxation agreement, see DT1760.
