How do you work out how much profit belongs to a branch?
The starting point is not a formula but a functional analysis: what the people at the permanent establishment actually do, which risks they control, and which assets they use. The permanent establishment is then treated as if it were a separate enterprise dealing at arm's length with the rest of the company, and the notional dealings between them — services provided, assets made available, funding supplied — are priced accordingly. The profit that follows is the profit attributable to it. Turnover keys and share-of-revenue splits are sometimes used as a shortcut, and they are the first thing an examination takes apart.
Can a branch deduct head office costs?
In principle yes, to the extent the branch actually received something. The analysis asks what the rest of the enterprise did for the permanent establishment, whether an independent business would have paid for it, and what the arm's length price would be. Costs that benefit the enterprise as a whole, or that relate to shareholder-type activity rather than a service to the branch, sit differently. Some systems also impose their own domestic restrictions on what a branch may deduct, so the treaty analysis and the local rule both have to be run. The allocation key matters less than the evidence of benefit.
Why does my branch show a profit when the company lost money?
Because attribution follows what the permanent establishment does, not the consolidated result. If the people at the branch perform functions and control risks that an independent business would be paid for, the branch is attributed a return for them even in a year the enterprise as a whole lost money elsewhere. The reverse happens too: a profitable group can have a loss-making branch. Nothing in the exercise caps the branch at a share of the overall outcome, which is why enterprises that compute the branch as a proportion of group profit find the figure hard to defend.
Does a permanent establishment need its own accounts?
It needs a set of accounts that can be produced, whether or not the accounting system was built to produce one. In practice that means identifying the transactions belonging to the permanent establishment, the direct costs it incurred, the notional dealings with the rest of the enterprise and the capital attributed to it. Where nothing separate was kept, the accounts are constructed from the enterprise's own ledgers and working papers. Doing that contemporaneously is materially easier than doing it during an examination, and a computation prepared years afterwards carries less weight even when the figures in it are right.
How much interest can a branch deduct on group funding?
Less than the intra-group loan agreement usually suggests. A permanent establishment is attributed an amount of notional capital of its own, sufficient to support the assets it uses and the risks it controls, because an independent business carrying on that activity would need capital of its own. Interest is then deductible on the funding above that level, priced at arm's length. Pushing debt into a branch beyond what its functions support is one of the most commonly adjusted items in this area, and the adjustment is made whatever the paperwork between the branch and head office says.
What if both countries attribute different profit to the branch?
That is the ordinary outcome when each side runs its own analysis, and it produces double taxation on the overlap. The residence state relieves the source state's tax on the profit it accepts is attributable there; where the two figures differ, part of the income is taxed twice with no relief against it. The route out is the treaty's mutual agreement procedure, in which the two authorities settle the attribution between them. What decides that process is the documentation: one consistent functional analysis, filed the same way in both countries, rather than two computations each built to suit its own return.
What is a permanent establishment, and how easily do we create one?
A taxable presence in another country under the treaty — typically a fixed place of business such as an office, branch, factory or workshop, or a dependent agent habitually concluding contracts on your behalf. Some treaties add a services test measured in days. Purely preparatory or auxiliary activity is excluded, but that carve-out is narrower than it sounds: one senior employee working from home in the other country, with authority, has been enough. See business profits and permanent establishment.
What happens if the two countries disagree about which of them can tax me?
The treaty has a procedure for exactly that. You apply to the competent authority in your residence country, which takes the case up with its counterpart, and the two negotiate a position that removes the double taxation. Some treaties add binding arbitration if they cannot agree. It is slow and it runs on documents, so the practical work is preserving the record and filing protective claims while the clock runs. See our treaty work.
