Attribution and allocation of profits between head office and PE

International allocation rules
For the purpose of allocating profits between the head office company and a PE,
Switzerland, on the international level, uses both the direct method (so-called
“objective method”), under which the PE is treated like an independent enterprise, and the indirect method described above (so-called “fractional method”).
The federal direct tax law recognizes that the fractional method is normally
applicable to a Swiss resident enterprise with a PE abroad.  Indeed, under article 6 paragraph 3 and article 52 paragraph 3 DTL the rules prohibiting intercantonal double taxation are applicable to Swiss residents with enterprises or a PE situated abroad, unless losses are reported in one or more of the countries involved.  According to the majority of commentators and the federal tax administration, however, the direct method of attribution is applicable to foreign residents with enterprises or PEs in Switzerland (article 6 paragraph 4 and article 52 paragraph 4 DTL). Historically, the direct method has been applicable where no proper documentation was available from the country of residence of the foreign company.

Implications for electronic commerce
To my knowledge, no specific method of allocation has yet been developed for
electronic commerce. According to the principle of neutrality, there seems to be no policy reason to treat electronic commerce differently from traditional commerce.
Therefore, the method of allocation applicable for electronic commerce
should correspond to the nature of what the customer purchases. He or she is
doing nothing other than buying a specific good (in digitized form) or a service.
As mentioned above, however, only in rare cases could the presence of a
server in the territory of a country qualify as a PE. This could be the case, for
instance, with a gambling server, which performs the core business of a gambling enterprise sited abroad. Consequently, the question of attribution of profits between the head office and a PE in another country – caused solely by the presence of a server in that country – should rarely occur. The situation would of course be different if, in addition to the server, there were human personnel engaged in activities that could be regarded as an essential part of the core business of the electronic commerce enterprise.
According to leading opinions, for a Swiss PE of a foreign company, the direct
method of attribution should apply. In particular, losses incurred by a foreign
company are not deductible from the taxable profits attributable to the Swiss PE (article 52 paragraph 4 DTL). The application of the direct method presents the same difficulty mentioned above for the attribution of profits to a Swiss subsidiary (transfer pricing) because the PE has to be treated as an independent
enterprise entering into arm’s length transactions with its counterpart.
The wording of article 52 paragraph 3 DTL indicates that the attribution of
profits of foreign PEs of Swiss companies could arguably be done in accordance
with the fractional (indirect) method. Should this be the case, it would be difficult to define the appropriate apportionment rule. In essence, electronic commerce is not the same as telecommunication or transport. At least, according to the principle of neutrality, the indirect method based on turnover should be applied, paying due regard to the functions performed by the head office and, if any, other PEs, similarly to Swiss companies entering into traditional commerce within different cantons. It remains doubtful, however, that the use of the fractional method is adequate in this situation. In my view, in the case, albeit limited, where a server as such could be regarded as a PE, the only appropriate method is also the direct method.

Therefore, as a general rule, the attribution of profits of the PE should correspond to the functions performed, assets used and risk borne by the server under the arm’s length principle. If the server alone constitutes the PE, the amount attributable to its function will most likely be insignificant. Under Swiss practice, the cost plus method could be applied since servers usually perform service functions.