tax notes international - Tuck School of Business - Dartmouth College

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that must be satisfied before a country can tax residents of other treaty countries on their profits derived from the other country.’’ 12 At this stage, it is worthwhile to remember what Kees van Raad cited as one of the fundamental rules in applying tax treaties, that ‘‘tax treaties restrict the application of internal tax law.’’ 13 Stated differently, a tax treaty might restrict taxation, but not impose a tax that does not otherwise exist under domestic law. The main purpose of tax treaties is to establish a mechanism to avoid double taxation by restricting tax claims in areas where overlapping tax claims are expected to occur. 14 In this sense, the PE threshold must be met to allow the host state to tax the items of income arising within its territory, if its domestic law so provides. Broadly speaking, the rationale behind the PE provision is that as the enterprise is deriving profits in the host state by having a presence thereof, that is, by being economically connected with that state and using its infrastructure, the host state should be entitled to tax such profits. The characterization of a PE is governed by article 5, provided that the relevant states concluded an OECD-patterned treaty. For the present analysis, what is relevant is the characterization of an agency PE, which is governed by the provisions of article 5, paragraph 5 of the OECD model tax convention. The first use of article 5, paragraph 5 in a model dates back to the 1935 League of Nations draft. 15 The underlying principle of this provision is that a person acting on behalf of the enterprise in the host state leads to a taxable presence thereof, that is, a PE, even though the enterprise may not have a fixed place of business in that state in the sense of paragraphs 1 and 2 of article 5. 16 This particular feature of the agency PE — irrelevance of a fixed place of business — illustrates the difficulty in characterizing such a PE in practice, as opposed to the physical PE set forth in article 5, paragraphs 1 and 2. While the characterization of the latter type is rather obvious, tax authorities face a more difficult task in identifying agency PEs because of 12 Brian J. Arnold, ‘‘Threshold Requirements for Taxing Business Profits Under Tax Treaties,’’ Bulletin — Tax Treaty Monitor (Oct. 2003), pp. 476-492. 13 Kees van Raad, ‘‘Five Fundamental Rules in Applying Tax Treaties,’’ Liber Amicorum Luc Hinnekens (Bruxelles: Bruylant, 2002), pp. 587-597. 14 Vogel, supra note 3, at 27. 15 John F. Avery Jones et al., ‘‘The Origins of Concepts and Expressions Used in the OECD Model and Their Adoption by States,’’ Bulletin — Tax Treaty Monitor (June 2006), p. 237. 16 Vogel, supra note 3, at 329. the need to focus on the activities of the enterprise as carried out by the dependent agent. 17 Under article 5, paragraph 5 of the OECD model tax convention, an agency PE is found to exist when the following characteristics are met: (i) a person (individual or company) is acting on behalf of the enterprise, (ii) other than an agent of independent status, (iii) with authority to conclude contracts, (iv) in the name of the enterprise, (v) on a regular basis. In the OECD language, as long as these requirements are met, the agency PE is characterized a dependent agent (DA) and a dependent agent PE (DAPE). There are countless debatable questions in connection with each of these requirements, all of which, however, fall outside the scope of this article. 18 For the purposes of this article, it is assumed that every time an agency PE is mentioned, the requirements at stake were met. In this context, though this is not the core issue of this article, the scope of article 5, paragraphs 5 and 6 of the OECD model convention is quite disputable among scholars, especially when it comes to the difference between common-law and civil-law practitioners. From a common-law perspective, it is often argued that article 5, paragraphs 5 and 6 cover only agents concluding contracts binding on their principal. 19 However, a different view based on civil law is that article 5(5) of the OECD model convention refers to direct representatives, while article 5(6) relates to indirect representatives. 20 These diverse views reflect the essential difference between common and civil law: When an agent makes a contract in his own name, but on behalf of an undisclosed principal, as a general rule under common law, the principal is bound by the contract, whereas under civil law, again as a general rule, only the agent, and not the principal, is bound by such a contract. 21 This difference between common and civil law is often viewed as a tax planning opportunity. Multinational enterprises will take into account all the abovementioned factors that characterize an agency PE when setting up a business abroad. Under their supply chain management and international tax planning strategy, multinational enterprises will often seek to structure their activities in a foreign country in a manner 17 Arnold, supra note 12, at 479. 18 For reference to the controversial issues involving the agency PE notion, see Giuseppe Persico, ‘‘Agency Permanent Establishment Under Article 5 of the OECD Model Convention,’’ Intertax, Vol. 28, No. 2 (2000), pp. 66-82. 19 John F. Avery Jones and David A. Ward, ‘‘Agents as Permanent Establishments Under the OECD Model Tax Convention,’’ Eur. Tax’n (May 1993), pp. 154-181. 20 Sidney I. Roberts, ‘‘The Agency Element of Permanent Establishment: The OECD Commentaries From the Civil Law View,’’ Eur. Tax’n (Mar. 2008), pp. 107-113. 21 Avery Jones and Ward, supra note 19, at 156. SPECIAL REPORTS TAX NOTES INTERNATIONAL FEBRUARY 2, 2009 • 423 (C) Tax Analysts 2009. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content.
SPECIAL REPORTS that either avoids the characterization of an agency PE 22 or provides for an optimal allocation of functions, assets, and risks to shift income to a low-tax jurisdiction. Taking into account a particular company willing to distribute its goods in a foreign country, there are basically two distribution models that may be adopted to accomplish this goal: (i) the buy-sell model, involving a local distributor that may be related to the company, and (ii) the agency model. Both models have their variances, triggering different tax consequences, and often multinational enterprises play around with the features of each model to shift income to a low-tax jurisdiction (for example, by using a limited risk distribution model, under which part of the risk is shifted from the distributor to the principal, so the former is entitled to a lower profit). Essentially, the allocation of functions, assets, and risks will determine the arm’s-length remuneration of a distributor in a buy-sell model. However, one of the main tax consequences of the agency model is the possibility of the constitution of an agency PE in the host state once the requirements of article 5, paragraph 5 of the OECD model tax convention are met. Because of the extensive use of the OECD model convention and its commentary and the development of case law and doctrine, it can be said that nowadays the characterization of an agency PE is not as complicated as it was in the past, although it still requires a case-by-case analysis. Nonetheless, an open question, both to tax authorities and taxpayers, is how much profits must be attributed to that PE. III. Subsidiary Constituting an Agency PE Before addressing the core issue of the different approaches to attribute profits to agency PEs, attention should be given to the particular phenomenon of a subsidiary constituting an agency PE of its foreign parent company, as this might lead to different consequences regarding the attribution of profits to that PE. The provisions of article 5, paragraph 7 of the OECD model tax convention set forth that: the fact that a company which is a resident of a contracting state controls or is controlled by a company which is a resident of the other contracting state, or which carries on business in that other state (whether through a PE or otherwise), shall not of itself constitute either company a PE of the other. This ‘‘anti-single-entity’’ clause makes clear that a subsidiary should not be considered a PE of its parent company for the mere fact of their corporate relationship (that is, that they belong to the same group of companies). 22 Arnold, supra note 12, at 483. The commentaries on article 5, paragraph 7 of the OECD model tax convention reaffirm this rule and stress that the fact that the trade or business carried on by the subsidiary company is managed by the parent company is not sufficient to consider the former a PE of the latter. However, it is also generally accepted that the subsidiary cannot hide behind its independent legal status to avoid an agency PE characterization because ‘‘there is no reason why a subsidiary company acting as an agent of its parent company should be treated differently than a third party acting as an agent.’’ 23 In the same way, the commentaries on article 5, paragraph 7 provide for this possibility. As will be demonstrated below, several decisions were issued recently recognizing the existence of a subsidiary constituting a PE of its parent company. The decisions were not always received by the international tax community free of criticism. A. Interhome The Interhome case24 involves a decision of the Conseil d’Etat (Supreme Administrative Court of France) ruling that a French subsidiary (Interhome Gestion) may constitute an agency PE of its Swiss parent company (Interhome AG), but only if the former: • cannot be regarded as an independent agent of its parent company; and • habitually exercises an authority to bind the Swiss parent in commercial activities that are related to those of the parent. Interhome AG is a group of companies headquartered in Switzerland engaged in the business of renting holiday accommodations. In this context, Interhome AG concluded mandate contracts with owners in several European countries and promoted the houses in a catalogue, while its subsidiary in France — Interhome Gestion — was responsible for the proper execution of these contracts within the French territory. 25 (See Figure 1.) Under this scenario, French tax authorities argued that Interhome Gestion should be considered an agency PE of Interhome AG and therefore the income received by the latter, comprised of commission on the rents, should be taxed in France as profits attributable to that PE. 26 23 Arthur Pleijseir, ‘‘The Agency Permanent Establishment, Practical Applications. Part Two,’’ Intertax, Vol. 29, Nos. 6-7, (2001), pp. 223-224. 24 Conseil d’Etat (Supreme Administrative Court of France), June 20, 2003, decision 224407. 25 Id. 424 • FEBRUARY 2, 2009 TAX NOTES INTERNATIONAL 26 Id. (C) Tax Analysts 2009. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content.
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