1. Introduction

Art. 7(2) in most contemporary tax treaties requires a permanent establishment (PE) to be deemed as independent of the enterprise (head office) to which it belongs. This principle is often referred to as separate enterprise hypothesis or independent enterprise hypothesis.

But, how far can we stretch the above-mentioned requirement of Art. 7(2) of a tax treaty?

Can the tax authorities of a Source State invoke the above-mentioned principle for taxing ‘payments’ by a permanent establishment to its overseas head office? Can it be invoked for deducting interest ‘payments’ by a permanent establishment to its head office? Should a permanent establishment’s liabilities ‘owed’ to its head office required to be taken into account? Can the tax authorities of the Residence State deem an enterprise to have earned income on account of transfer of inventory to a permanent establishment? Would the separate entity/ independent enterprise hypothesis prevail over conflicting income apportionment provisions?

This article examines the above-mentioned scenarios with help of the important judicial precedents in various jurisdictions such as Canada, Denmark, Germany, Switzerland and India.