tax notes international - Tuck School of Business - Dartmouth College

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OECD model convention are not met and therefore no agency PE is found to exist. 43 It is up to dispute among scholars whether commissionaires fall under the scope of article 5(5) of the OECD model convention, especially because of the diverse views arising from the common-law and civil-law notions of agents. One might argue that economically the commissionaire performs basically the same activities as a conventional agent under article 5(5) of the OECD model convention, but legally there is no contractual relationship between the customer and the principal. The customers only have a contractual relationship and therefore can only sue the commissionaire, not the principal, which is why the characterization of a typical commissionaire as an agent within the meaning of article 5(5) of the OECD model convention is, in my view, unreasonable. That was not the interpretation of the Court of Appeals of Paris in concluding that Zimmer SAS could de facto bind its parent company, Zimmer Ltd. Phrased differently, the court clearly adopted an economic substance approach to conclude that the principal was actually bound by the commissionaire. This should not be considered a good decision because it ignored the particular features of a commissionaire arrangement, a typical concept of civil-law jurisdictions. It is therefore expected that tax authorities, especially in France, will feel encouraged to challenge commissionaire structures on the basis of an economic approach. Despite this controversial issue of the substanceover-form approach adopted by the Court of Appeals of Paris, the question of what portion of profits should be attributed to that PE remained unanswered. This question is addressed in the following section. A. Introduction IV. Different Approaches The origins of article 7 of the current OECD model convention dates back to the 1920s and to the work of the League of Nations, predecessor of the OECD. At that time, under the 1927 League of Nations draft convention, article 5 governed the taxation of what was then called ‘‘income from a trade or profession’’; there was little guidance on how to determine the income taxable in each contracting state. 44 43 See Stéphane Gelin and David Sorel, ‘‘French Commissionnaire: A PE for Its Foreign Principal?’’ Tax Notes Int’l, Aug.6, 2007, p. 581, Doc 2007-16318, or2007 WTD 154-6. 44 Raffaele Russo, ‘‘Tax Treatment of ‘Dealings’ Between Different Parts of the Same Enterprise Under Article 7 of the OECD Model: Almost a Century of Uncertainty,’’ Bulletin — Tax Treaty Monitor (Oct. 2004), pp. 472-485. SPECIAL REPORTS The current wording of article 7(2) establishing the separate enterprise concept — that the profits of a PE will be ‘‘the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a PE’’ — has its origins in article 3 of the 1933 League of Nations draft convention and was generally followed by the subsequent Mexico and London model conventions of 1943 and 1946, respectively. 45 There are two main interpretations of article 7 regarding the attribution of profits to PEs. Since then, the study of the issue of attribution of profits to PEs has evolved greatly, but despite the efforts of the OECD no consensus has been achieved among states until the recent adoption of the revised commentary on the current article 7 to be included in the 2008 update to the model tax convention. This revised commentary is a great achievement and will provide more guidance on this issue. There are two main interpretations of article 7 regarding the attribution of profits to PEs: the functionally separate entity approach, also known as the authorized OECD approach; and the relevant business activity approach. Generally, the authorized OECD approach provides that the profits to be attributed to a PE must be the profits that it ‘‘would have earned at arm’s length if it were a legally distinct and separate enterprise performing the same or similar functions under the same or similar conditions.’’ 46 The relevant business activity approach provides that the expression ‘‘profits of an enterprise’’ in article 7(1) of the OECD model convention refers to the profits of business activities in which the PE has participated. The main feature of this approach is that ‘‘profits are earned only from transactions with third parties (or with associated enterprises): no profit is earned from a transaction between the PE and the enterprise of which it is part.’’ 47 Under the relevant business activity approach, article 7(1) limits 45 Id. at 474; see also para. 81 of the OECD ‘‘Report on the Attribution of Profits to Permanent Establishments,’’ Part I (General Considerations), (2006). 46 Para. 10 of the ‘‘Report on the Attribution of Profits to Permanent Establishments,’’ Part I (General Considerations), (2006). 47 Baker and Collier, supra note 7, at 30. TAX NOTES INTERNATIONAL FEBRUARY 2, 2009 • 429 (C) Tax Analysts 2009. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content.
SPECIAL REPORTS the profits that may be attributable to a PE, on the basis of article 7(2), to the overall profits of the whole enterprise. One major consequence of this is the impossibility of attributing profits to a particular PE if the enterprise, considered as whole, makes a loss. When it comes to the attribution of profits to agency PEs, the controversial issue is determining whether there may be a profit attributable to the agency PE in excess of the arm’s-length remuneration paid to the dependent agent. The issue is whether it is possible to attribute a separate profit to an agency PE once the agent had an arm’s-length reward for the service provided. The two different approaches provide for completely different answers: The application of the authorized OECD approach to agency PEs leads to the possibility of a separate profit and loss attribution to that PE, while the single taxpayer approach provides that once the dependent agent received an arm’s-length reward, no profit or loss can be attributed by the host state. The authorized OECD approach leads to the treatment of the dependent agent and the agency PE as two different taxable entities (also known as the dual taxpayer approach). Conversely, the single taxpayer approach provides that an arm’s-length remuneration paid only to the dependent agent is in compliance with the PE treshhold. B. OECD Project on Attribution of Profits to PEs Before analyzing the authorized OECD approach in detail, it is important to present an overview of the OECD project on attribution of profits to permanent establishments to examine what is the legal status of such approach as well as its role in interpreting current treaties. This analysis is necessary since one of the main controversies regarding the authorized OECD approach refers to its applicability regarding treaties currently in force. While some argue that the approach is the most proper interpretation of article 7 of the current version of the OECD model convention, others argue that the application of the authorized OECD approach is dependent on changes to be made in the wording of tax treaties and therefore cannot be applied to the treaties currently in force. The starting point of this project was the OECD’s attempt to analyze how the principles developed in the 1995 OECD transfer pricing guidelines, which deals with the application of the arm’s-length principle to transactions between associated enterprises, should apply in the context of the relationship between a PE and its general enterprise. 48 The aim of this effort was to achieve a greater consensus on the attribution of profits 48 Para. 2 of the update of the status of the OECD project on the attribution of profits to PEs (2006). to PEs and the interpretation of article 7 of the OECD model tax convention, avoiding the risk of double taxation. In this context, the OECD released in 2001 parts I (General Considerations) and II (Banks) 49 and in 2003 Part III (Global Trading) 50 of a discussion draft on the attribution of profits to PEs. In 2004 a revised discussion draft of parts I, 51 II, and III was released for public comment. Finally, in December 2006, the Committee on Fiscal Affairs released new versions of parts I, II, and III of its ‘‘Report on the Attribution of Profits to Permanent Establishments.’’ 52 Moreover, in December 2006 the OECD Committee on Fiscal Affairs decided that to provide ‘‘improved certainty for the interpretation of existing treaties based on the current text of article 7, a revised Commentary should be prepared taking into account those aspects of the Report that do not conflict with the existing Commentary’’ (aspects that constitute a mere clarification of the proper interpretation of article 7). 53 Therefore, on April 10, 2007, as a first part of the implementation package, a discussion draft of the revised commentary on article 7 was released for public comment taking into account many of the conclusions included in parts I, II, and III of the ‘‘Report on the Attribution of Profits to Permanent Establishments.’’ 54 The revised commentary on the current article 7 of the OECD model tax convention was then included in the 2008 update to the model tax convention, which was adopted by the committee at its meeting of June 24-25, 2008, when the committee also adopted the ‘‘Report on Attribution of Profits to Permanent Establishments.’’ The revised commentary will be included in the new version of the OECD model tax convention that will soon be published; the report will also be published separately. 55 Furthermore, the OECD Committee on Fiscal Affairs intends to implement the conclusions of the report not only through a new version of the commentary on the current text of article 7, but also through a new version of article 7 itself with accompanying new 49 See http://www.oecd.org/LongAbstract/ 0,3425,en_2649_201185_1923011_1_1_1_1,00.html. 50 See http://www.oecd.org/LongAbstract/ 0,3425,en_2649_201185_2497688_1_1_1_1,00.html. 51 See http://www.oecd.org/LongAbstract/ 0,3425,en_2649_201185_33637686_1_1_1_1,00.html. 52 See http://www.oecd.org/LongAbstract/ 0,3425,en_2649_201185_37861284_1_1_1_1,00.html. 53 See http://www.oecd.org/LongAbstract/ 0,3425,en_2649_201185_38361712_1_1_1_1,00.html. 54 See http://www.oecd.org/document/52/ 0,3343,en_2649_201185_38376628_1_1_1_1,00.html. 55 See http://www.oecd.org/document/52/ 0,3343,en_2649_33747_38376628_1_1_1_1,00.html. 430 • FEBRUARY 2, 2009 TAX NOTES INTERNATIONAL (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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