OECD Authorized OECD Approach Permanent Establishment Profit Attribution Framework
The Authorized OECD Approach attributes branch profits by treating permanent establishments as separate enterprises through functional and economic analysis.
Risk Assumption
Meaning
An economic analysis determines which party to a transaction bears the financial consequences of a specific business risk under the terms of a transfer pricing agreement. The process of risk assumption evaluates whether a local subsidiary or its foreign parent actually has the decision-making authority and financial capacity to manage and bear the risk. This analysis is central to determining the arm’s length profit allocation between related entities.
It does not apply to risks that are not actively managed or controlled by either party.
Functional Control
The allocation of risk for tax purposes depends on who performs the control functions and holds the financial capacity to bear that risk. A party cannot be allocated a risk if it merely signs a contract but lacks the employees or expertise to monitor and mitigate that risk.
Transfer Pricing
Allocating risk to a party entitles them to a higher share of the profits or forces them to bear the resulting losses if the risk materializes. This pricing model reflects the market principle that higher risk-bearing requires a higher expected return. If the risk is borne by the parent company, the local manufacturing subsidiary is typically allocated a low but stable return.
This stabilizes the subsidiary’s tax base.
Contractual Alignment
Tax authorities will disregard the written contract if it does not match the actual behavior and decision-making of the parties. This means that a subsidiary that is contractually obligated to bear inventory risk but lacks the storage or management capabilities will not be recognized as the risk-bearer. This discrepancy leads to tax adjustments and potential double taxation if the transfer prices are recalculated.