One of the most important advantages of the Article 7 approach is that it provides for net taxation of income from services. However, the attribution of profits to a PE is frequently a complex issue, particularly where there is no branch or other discrete part of the enterprise that would ordinarily keep separate books of account in respect of its activities. The compliance and administrative burden of computing the profits attributable to the PE should not be underestimated. The problems become more acute when “force of attraction” rules apply, even in the more limited form provided in subparagraph (c) of Article 7(1) of the UN Model.
Double taxation of PE profits is frequently relieved by the country of residence of the SP by the exemption method, although the credit method is used in many countries. Exemption of the profits in the residence country ensures that the SP is not at a competitive disadvantage in relation to the activities carried on in the host State, and generally imposes a lower compliance burden on the enterprise than the credit method. Because tax may only be imposed on a net basis in the host jurisdiction, excessive taxation - at least vis-a-vis another enterprise that is resident in the host jurisdiction - is avoided.
However, where the PE jurisdiction taxes income from services provided outside that jurisdiction through the PE. unrelieved double taxation may still arise if tax is imposed in the country in which the services are provided.
Example: Rco, a resident of R. derives income from the provision of services in S through its PE in P. Tax is imposed on the services income in S on a source basis, in P as income attributable to a PE, and in R on a residence basis. R and P will relieve double tax only under a tax treaty. R has a treaty with P, but not with S. R will therefore relieve the tax imposed in P in accordance with the R-P treaty, but will not relieve the S tax.
P has treaties with both R and S. Because the PE is not a resident of P, it is not entitled to the benefits of the P-S treaty. Accordingly S is not obliged to restrict its tax on the services income and P is not obliged to relieve the tax imposed in S under the relief article. Nor is P obliged to provide double tax relief to the PE under paragraph 3 of the non-discrimination article of the R-P treaty, unless P provides double tax relief to its residents under its domestic law.