INTM200300 - Controlled Foreign Companies: The CFC Charge Gateway Chapter 4 - Profits attributable to UK activities: Identification of SPFs
The Organisation for Economic Co-operation and Development’s (OECD)2010 Report on the Attribution of Profits to Permanent Establishments (“the Report”) does not try to give a general definition of , key entrepreneurial risk-taking functions (KERTs) or significant people functions (SPFs) relevant to the assumption of risk, or of those relevant to the economic ownership of assets. Rather, it sets out how these functions are to be identified in the context of the activities of the business, typically as functions that require active decision-making. It makes it clear that these functions will vary between business sectors and between enterprises in those sectors.
Once identified in the functional and factual analysis, KERTs or SPFs are used as the basis of attributing assets and risks to the enterprise’s PEs in accordance with where in the enterprise these functions are carried out.
The use of the separate terms, KERTs and SPFs is mentioned in INTM200200 and is discussed in the Report at paragraph 16 of Part I. The Report goes on to say at paragraph 22 of Part I, “the significant people functions relevant to the assumption of risks are those which require active decision-making with regard to the acceptance and/or management (subsequent to the transfer) of those risks”. An example to illustrate this is provided at paragraphs 23 to 25 of Part I.
Part 1 paragraph 23
By way of illustration, take the example of an enterprise which consists of a head office in one jurisdiction and one PE in another jurisdiction. Assume products are manufactured at the head office location and delivered to the PE premises for sale to customers in the PE jurisdiction. Assume the manufacturing functions are performed by employees of the head office and the sales are concluded by employees of the PE. A functional and factual analysis is performed and concludes that in this particular instance this particular PE is acting as a distributor of the head office products. In this example it might be necessary to attribute, among others, excess inventory risk and credit risk.
Part 1 paragraph 24
Under the authorised OECD approach, the attribution of these risks within the single enterprise will follow from the identification of the significant people functions relevant to the initial acceptance and subsequent management of those risks:
- The excess inventory risk is likely to be regarded as initially assumed by that part of the enterprise which makes the active decisions related to inventory levels. Depending on the circumstances of the case, this may be either the head office or the PE.
- The credit risk is likely to be regarded as initially assumed by that part of the enterprise which decides to conclude a sale to a particular customer after having reviewed the creditworthiness of this customer. A question may arise however where a review of the creditworthiness of each customer is performed by one part of the enterprise before a sale is concluded by another part of the enterprise. In such a case, the functional and factual analysis would have to examine whether the people in charge of reviewing the customers‘ creditworthiness are in effect the ones making a decision that leads to the assumption of credit risk, or if they act as a support function for the PE which ultimately makes the decision of whether or not to sell to a particular customer.
Part 1 paragraph 25
Note that the fact that general parameters for inventory levels or credit risks might potentially be set by another part of the enterprise would not change the assumption of the risk, as the significant people functions relevant to the assumption of risks are those which involve active decision-making.
Types of Asset
Part I of the Report returns to discuss the attribution of economic ownership of assets at paragraphs 72 to 97. Paragraph 75 endorses a pragmatic solution in the case of tangible assets for which economic ownership is generally attributed on the basis of where those assets are used. This approach is qualified by the words, “in the absence of circumstances in a particular case that warrant a different view”. This might be, for example, where the use of a tangible asset frequently moves, or is difficult to determine for some other reason.
For the purposes of Chapter 4, it is likely that any analysis of assets will focus on intangible assets or financial assets which are generally more mobile than tangible assets. It is not expected that the attribution of the ownership of tangible assets will be such an issue in identifying Chapter 4 profits although Chapter 4 profits may be identified in respect of specific risks that are connected with tangible assets where such risks and the related rewards are allocated to a CFC but assumed and / or managed in the UK.
It is important to remember that the Report focuses on the interpretation and application of the business profits article (Article 7) of the OECD Model Tax Convention (MTC). The attribution of assets and risks to a permanent establishment (“PE”) is part of the first step in attributing the appropriate amount of profits to the PE for the purposes of Article 7. Income from immovable property is dealt with under Article 6 of the OECD MTC rather than Article 7 (business profits) which deals with the attribution of profits to PEs. Article 6 gives taxing rights based on the location of the property, so it is not necessary to consider the attribution of economic ownership of immovable property situated in the territory of the PE under the MTC.