handbook-tb

Limiting interest deductionsOECD Model Tax Convention on Income and on Capital 4 (OECDModel Convention), a corporation that has a taxable presence (a “permanentestablishment,” or PE, under Article 5) in another country istaxable in that other country on the profits “attributable to” the PE,determined by treating the PE as if it were a distinct and separate legalentity from the rest of the enterprise, engaged in the same or similaractivities under the same or similar conditions and dealing whollyindependently with the enterprise of which it is a PE. The PE willmaintain books and records of its income and expenses.With respect to interest expense, however, there is someinconsistency:‣ ¾ In some cases, the PE calculates its interest expense as if it werea separate legal entity from the parent, based on its own booksand records;‣ ¾ In other situations, however, the PE determines its interestexpense as a share of the total interest expense incurred by theenterprise of which it is a part. Article 7 (Business profits) of theUnited Nations Model Convention specifically provides that,except in the case of a bank, a PE will not be allowed a deductionfor any interest that is notionally charged to the PE by thehead office (nor will the PE be considered to earn any interestthat it notionally charges to the head office or another branch).Instead, the PE will be entitled to a deduction for its “allocableshare” of interest expense incurred by the enterprise as a whole. 5If a branch is allocated a share of the interest expense incurredby the enterprise to which it belongs, that amount may, of course,be greater or smaller than the amount that would be determined bytreating the branch as a separate entity. The argument in favour of4OECD, Model Tax Convention on Income and on Capital (Paris:OECD, 2014).5For more information on this issue, see paragraph 3 of the Commentaryon Article 7 of the United Nations Model Convention; and Jinyan Li,“Taxation of non-residents on business profits,” in United Nations Handbookon Selected Issues in Administration of Double Tax Treaties for DevelopingCountries (New York: United Nations, 2013), available at http://www.un.org/esa/ffd/documents/UN_Handbook_DTT_Admin.pdf.183