12 - Conclusion

Summary

International enterprises operating through permanent establishments around the world are difficult to tax at a national level because they operate as unitary worldwide businesses. Any mechanism that seeks to attribute the profits of an international enterprise to a country in which it operates through a permanent establishment will be arbitrary because profits and expenses of an international enterprise do not have geographic indicia, they are merely the profits and costs of the enterprise. Not surprisingly, international enterprises seek to maximize their profits and minimize their tax obligations. International enterprises are able to engage in tax arbitrage by exploiting the differences between tax systems in the countries in which they operate. Tax authorities operate at a national level and cannot realistically rely on the goodwill of international enterprises to comply with tax laws. The present tax treaty system – using bilateral tax treaties and the arm's length principle to allocate business profits to permanent establishments of international enterprises – is fundamentally flawed in theory and practice, and reform has become a pressing issue in the globalized international economy. These flaws have become magnified in the past forty years with the globalization and the rapid global expansion of international enterprises, such as international banks. The flaws in the current tax treaty system have been recognized and debated for some years, the system being described as the flawed miracle. The system is a miracle, in that the tax treaties reflect the OECD Model and it has broad support. But it is flawed, because the system was designed in the early part of the twentieth century and has been eroded by progressive globalization.

This book asserted that the arm's length principle, on which former Article 7 and new Article 7 of the OECD Model are based, is an inappropriate principle for attributing profits to permanent establishments of international enterprises. International enterprises, such as international banks, operate through branches as highly integrated businesses with a common profit motive. Conversely, the relationship between independent enterprises is based on the contracts between them. The assumption that permanent establishments and the other parts of an international enterprise can be treated as separate enterprises operating at arm's length conflicts with the economic theory of the firm and business reality. Thus, the arm's length principle is the wrong norm to use in attributing profits to permanent establishments of international enterprises, such as branches of international banks, because they operate as unitary businesses.