The New Permanent Establishment Status After BEPS: Déjà Vu In France?

The final report on Action 7 of the BEPS initiative (Preventing the artificial avoidance of Permanent Establishment Status – OECD – October 2015) proposes to amend significantly Article 5 of the OECD Treaty Model as well as the related comments. Interestingly enough, if the part of the report addressing commissionnaire arrangements directly tackles French case law, the amendments applicable to dependent agents and to the Article 5 (4) dealing with preparatory and auxiliary activities are quite in line with French domestic law applicable to non-residents carrying on a taxable activity in France. As a consequence, multinational companies based in a Treaty country may have as little protection with regards to permanent establishments in France than foreign companies based in tax havens which have not signed any tax treaty with France.

1. French Case Law On Commissionnaire Tackled By BEPS, But With Which Consequences?

On March 31, 2010, the Conseil d'Etat (French Supreme Administrative Court)¹ held a long-awaited judgment in the Zimmer case, dealing with the consequences of a commissionnaire presence in France as regards permanent establishment (PE) characterization and liability for corporate income tax in France under the French–UK Tax Treaty. The commissionnaire status is specific to civil law: a commissionnaire concludes contracts in its own name, but on behalf of its principal; for its clients, a commissionnaire acts as if it were a distributor, while with respect to its principal, the commissionnaire never takes legal title on the product acquired by the client. The Conseil d'Etat ruled that a company acting as a commissionnaire may not constitute a PE of another company acting as principal where it does not have the authority to conclude contracts with third parties which are legally binding for the principal. It gave clear priority to the legal analysis over the economic approach of the relationship between the commissionnaire and the principal. According to the Conseil d'Etat, contracts concluded by the commissionnaire do not create obligations on the principal vis-à-vis the commissionnaire's clients, even though they may be concluded for the principal. Therefore, the mere fact that the agent sells the principal's goods or services while signing the contracts in its own name does not imply that it is a PE of the latter.

Action 7 of the BEPS initiative specifically addressed the status of commissionaire in order to close what was seen as a loophole by tax administrations. As a consequence, in the new wording of Article 5 of the OECD Model Treaty, the powers of the intermediary acting on behalf of the enterprise are specified and extended. Thus, a PE is constituted by any person acting in the Contracting State on behalf of any enterprise whatsoever for the conclusion of contracts in connection with the performance of its normal activity, or which plays a preponderant role in the conclusion of a contract in the Contracting State without the enterprise situated in the other Contracting State having the need to make substantial modifications to the contract.

Furthermore, the objective of the contracts is also modified. They must be concluded in the name of the enterprise, or have the objective of the transfer of ownership or the granting of the right to use an asset belonging to the enterprise or which it has the right to use, or have the objective of providing a service by the enterprise.

Because the Conseil d'Etat relied on both French civil law and the wording of the French–UK Tax Treaty, the amendment of the OECD Model Treaty provided by Action 7 should create a PE for non-resident principals appointing a French commissionnaire. Indeed, even if it could still be considered that the commissionaire does not conclude contracts on behalf of a principal under French law, the contract signed by the commissionaire in France would indeed transfer the ownership of an asset from the principal to the end customer. The new wording of the OECD Model Treaty would then be very effective in characterizing a PE when a commissionaire is involved.

Yet, the consequences of the amendment may not be as ground-shaking as expected. First, many multinational companies have replaced sales agents (disclosed or not) by limited risk distributors because of the uncertainty on the tax treatment of commissionaires in civil law countries. Second, the level of profit attributable to the PE created by a commissionaire may be quite difficult to ascertain: assuming the commissionaire is correctly compensated for the functions it performs, the assets it holds and the risks it bears, what is the amount of profit to be attributed to the functions, assets and risks allocated to the dependent agent permanent establishment (DAPE)? Indeed, it is generally considered that when a principal is deemed to have a PE because of the activity of a sales agent, such PE should be taxed on the profits a distributor would realize while using the assets and bearing the risks actually managed by the sales agent, as recommended by the new guidelines provided by the final report on Actions 8–10.

But if the commissionaire does not manage inventory or receivables for the account of the principal, the corresponding assets and risks should not be attributed to the DAPE. The only profit to be allocated to the DAPE would be those derived by a limited risk distributor holding no assets and bearing little risk, which should be quite similar to the profit derived by a sales agent; since the DAPE would need to compensate the commissionaire for its activity, no profit would be left for taxation at the level of the DAPE.

2. French Domestic Law On PE May Lead To A Tax Analysis Comparable To The One Deriving From The New Wording Of Article 5 Of The OECD Model Treaty

Under Article 209-I of the French Tax Code, only profits derived from enterprises operated in France or the taxation of which is attributed to France under a tax treaty are subject to French corporate income tax. A foreign corporation is, then, subject to corporate income tax on income derived from its operations in France.

According to case law of the Conseil d'Etat, three types of cases can be identified in which an enterprise may be deemed to be operated by a foreign corporation in France when the foreign corporation performs operations from an establishment located in France, or when the foreign corporation performs operations through a representative in France whose activity can be attributed to the foreign corporation; or when the foreign corporation performs a "complete commercial cycle" in France.

The examples presented below show that French courts have ruled in the first part of the twentieth century in a manner which is strangely similar to the new wording of Article 5 of the OECD Model Treaty.

a. Under the new wording of Article 5 of the OECD Treaty Model, the concept of auxiliary and preparatory activity is redefined

All of the activities provided for in paragraph 4 of Article 5 of the OECD Model are no longer automatically of a preparatory or auxiliary nature. It must be demonstrated that they are preparatory or auxiliary in order not to constitute a permanent establishment. A preparatory activity is an activity carried out in advance of the principal activity, the core activity of the entity, in order to prepare its implementation and correct performance. The auxiliary activity is defined as corresponding to an activity which supports the principal activity without directly taking part in this activity.

Under French domestic law, any non-temporary industrial or commercial installation that is independent and is at the disposal of a foreign corporation is generally considered to be an establishment. This includes branches, factories, purchase offices, shops, sales units and any other installations capable of generating profits.

French case law does not refer specifically to preparatory or auxiliary activities. But two cases addressed comparable situations: in one case, the presence in France of a purchasing office where an employee of a foreign corporation purchased goods to be sold abroad by the foreign corporation was considered to constitute an establishment subject to corporate income tax in France, as the French establishment was entitled to make operating decisions and was not confined to conveying purchase orders.² Conversely, the French Administrative Court of Appeal of Paris has ruled that a branch that coordinated and followed up on the advertising operations of other entities in the group to which it belonged without doing business was not an enterprise operated in France.³

The comparison of both cases could lead to the conclusion that activities which are truly preparatory or auxiliary activities would not constitute a PE in France, which is quite similar to the new OECD rules described above.

b. Under the new wording of Article 5 of the OECD Treaty Model, the concept of independence of the agent is significantly amended

Action 7 states that a person acting exclusively or almost exclusively on behalf of one or more enterprises to which it is closely connected may not be considered to be independent. Two enterprises are closely related when one of the entities controls the other or when the two enterprises are controlled by a third entity; with control being understood as the direct or indirect ownership of more than 50 percent of the shares or the voting rights and the rights to profits. Furthermore, as indicated above, a permanent establishment is constituted by any person which plays a preponderant role in the conclusion of a contract in the Contracting State.

Under French domestic law, a foreign corporation that carries out its transactions in France through a representative that has no independent professional capacity may be regarded as directly exercising its activity in France.

There is no legal definition of the circumstances in which such a representative constitutes an enterprise operated in France. Thus, the factual circumstances must be analyzed to determine whether a foreign corporation has a representative in France that constitutes an enterprise operated in France. A French representative of a foreign company acting in its own name should not a priori be regarded as constituting an enterprise operated in France. Instead, a representative constituting an enterprise operated in France will likely be a person that does not stand as an intermediary for the performance of the foreign company's activity, so that the foreign corporation may be considered to be carrying on a taxable activity in France directly and in its own name. For instance, a French representative who works in an office with the same trade name as the foreign corporation, who has an inventory and a proxy agreement to negotiate directly with customers, will result in the foreign corporation being in France with respect to the activity of the representative.⁴

Such a case law provides a solution which would be the same under the new wording of the OECD Treaty model where the agent plays a preponderant role in the conclusion of a contract.

c. Article 5 of the OECD Model Treaty provides for a new rule against fragmentation concerning preparatory or auxiliary activities

When a closely related enterprise or company performs activities in two distinct installations or when two related enterprises perform activities in the same installation and these activities constitute complementary functions forming part of a consistent commercial operation, these activities may not be taken in isolation. This new paragraph applies when at least two installations constitute a PE in the sense of Article 5 of the OECD Model or if all of the activities resulting from a combination of the various activities cannot be considered to be simply preparatory or auxiliary.

Under French domestic law, even if a foreign corporation has neither an establishment nor a representative in France, it may be subject to French corporate income tax on its profits if it regularly performs activities that constitute a "complete commercial cycle" in France.

According to administrative guidelines,⁵ "generally speaking, a complete commercial cycle corresponds to a set of commercial, industrial or craft operations having a pre-determined purpose, and making a consistent whole." In particular, purchase and sale transactions, manufacturing and sale transactions, and leasing transactions can constitute a complete commercial cycle. For instance, the French Supreme Court has held that a foreign corporation reselling in France products that it bought in France directly (or through intermediaries or representatives who were not acting in their own names) was subject to French corporate income tax even though it did not have any establishment in France.⁶

In particular, it should be noted that the French Supreme Court has held that a complete commercial cycle was performed in France, even where a step in the process was performed abroad (for example, packaging was performed abroad while sourcing, production and distribution were performed in France).⁷

It appears that the "complete commercial cycle" concept is quite close to the concept of "cohesive business operation" referred to in new Article 5.4.1.

Conclusion

It is not surprising that the outcome of the final report on Action 7 drives the wording of the OECD Treaty Model towards existing domestic law, as shows the French example, because the main purpose of domestic law is to attract profits into the local tax net: it is indeed the same purpose that governed Action 7. But domestic law is not aimed at eliminating double taxation, while the purpose of the OECD Model Treaty was indeed to do so. One can only hope that all countries will consistently follow the new guidelines for the application of the revised Article 5(4). Otherwise, there is no doubt that Action 14, which aims at making dispute resolution mechanisms more effective, will be extremely helpful.

Endnotes:
1 Conseil d'Etat, March 31, 2010, Nos 304715 and 308525, 10e and 9e s.-s., Sté Zimmer Ltd.
2 Conseil d'Etat, February 14, 1930, Reg. No. 12546 : Dupont 1930 p. 189, RO 5419; Conseil d'Etat, December 22, 1982, No. 26338, 8e and 9e s.-s. RJF 2/83 No. 185.
3 Administrative Court of Appeal of Paris, January 22, 1998, No. 94-1614, 2e ch., Sté Publicis FCB Europe (final judgment).
4 BOI-IS-CHAMP-60-10-30-20150701 No. 120.
5 BOI-IS-CHAMP-60-10-10-20140627 No. 210.
6 Conseil d'Etat, May 22, 1963, Reg. No. 46870, Dupont 1963 p. 601, RO p. 340.
7 Conseil d'Etat, November 13, 1964, Reg. Nos. 50944 and 60449: Dupont 1965 p. 30, RO, p. 185.