The judgment in the Zimmer case before the French Supreme Administrative Court was a long awaited one, which clearly presents a favourable result for those foreign companies having a Commissionaire presence in France.
In this landmark judgment delivered on March 31, the Conseil d'Etat(1) overruled the ruling of the Paris Administrative Court of Appeal and the French tax administration, holding that Zimmer SAS, the French company was not a permanent establishment (PE) of Zimmer Ltd, the UK company, and therefore Zimmer Ltd was not liable for corporate income tax in France.
Since the Commissionaire structure is very commonly used by foreign companies in France, this judgment will impact several companies. Stéphane Gelin and Daniel Gutmann analyse the implications of the ruling to the affected companies.
The Zimmer case decided
The "Zimmer" judgment released by the French Supreme Administrative Court (the "Conseil d'Etat") on March 31, 2010(2) was a long awaited one. It decides that a company acting as a Commissionaire may not constitute a permanent establishment 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. The status of Commissionaire is specific to civil law: a Commissionaire concludes contracts in its own name, but on behalf of his principal; for his clients, a Commissionaire acts as if it were a distributor, while with respect to his principal, the Commissionaire never takes legal title on the product acquired by the client.
Facts of the case
The case at hand involved a French company ("Zimmer SAS") which distributed orthopedic products while acting as a Commissionaire of a UK company ("Zimmer Ltd") as a result of a legal restructuring of the distribution process. The Administrative Court of Appeal had regarded Zimmer SAS as a permanent establishment of Zimmer Ltd for the purpose of implementing Article 4. 4 of the French-UK double tax treaty of May 22, 2008. According to the Court of Appeal(3), the French company was dependent upon the British company and could conclude contracts which were factually binding for the latter notwithstanding the fact that it acted in its own name. This decision had triggered numerous comments and criticisms(4). The Conseil d'Etat took them into account and did not follow the approach of the lower Court. It gave clear priority to the legal analysis over the economic approach of the relationship between the Commissionaire and the principal. The decision of Conseil d'Etat nevertheless leaves some questions open for the future.
The primacy of the legal approach
The Zimmer judgment is interesting in two respects:
- First of all, it confirms that the authority to conclude contracts which are binding for the principal should be understood in a purely legal way; and
- Secondly, it also makes it clear that a dependent agent's premises do not necessarily constitute a fixed place of business through which the business of an enterprise is wholly or partly carried on.
The authority to conclude contracts
According to the Conseil d'Etat, contracts concluded by the Commissionaire do not create obligations on the principal towards the Commissionaire'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 under his own name does not imply that he is a permanent establishment of the latter.
This legal analysis of the Commissionaire's contractual powers is perfectly in line with French civil law. The Court itself refers to the provisions of the Commerce Code to come to this conclusion(5), thereby following the opinion delivered by Advocate General Julie Burguburu who had underlined that this was also the view of the "Cour de cassation", namely the Supreme Court dealing with civil law issues.
The explicit confirmation of the relevance of civil law for the purpose of characterising a permanent establishment is worth noticing. It is indeed established that the concepts enshrined in Article 5.5 of the OECD Model were introduced with their civil law meaning, a point which the Advocate General had pointed out, quoting landmark academic contributions on the topic(6). The focus on the civil law approach is also interesting to the extent that it implicitly puts aside the concrete elements of the case which were used by the tax authorities to demonstrate that the Commissionaire could enter into "factually binding" contracts for the principal. This reasoning suggests that factual items revealing the actual influence of the principal on the agent are to be taken into account to assess the dependence of the latter upon the former, but do not affect the existence of a legal obligation borne by the principal by virtue of contracts concluded by the agent.
The concept of fixed place of business
According to Article 5.1 of the OECD Model (Article. 4.1 of the French-UK tax treaty), a “Permanent Establishment” may be defined as a fixed place of business through which the business of an enterprise is wholly or partly carried on. The OECD commentaries provide that the exercise of this activity may take place in the premises which belong to a subsidiary if they are at the disposal of the parent company(7). These commentaries are often used by the French tax authorities in order to state that a non-resident company has a fixed place of business in the offices of its French subsidiary. The Conseil d'Etat itself has recently provided for a good example of such a situation in a case involving a Luxembourg company(8). It should be noticed, however, that the facts where spectacularly unambiguous:
- Hundreds of documents with the Luxembourg company's overhead paper had been found in its French subsidiary's offices as well as invoices and other documents sent to clients and contractors;
- A French employee had signed documents issued by the Luxembourg company, received mail addressed to it and issued orders of delivery of goods;
- and The Luxembourg company had numerous bank accounts in France and only hired a part-time accountant in Luxembourg.
Several legal grounds were therefore available to the tax administration in order to tax the Luxembourg company, one of the important ones being the concept of ‘place of effective management’. The Conseil d'Etat focused on the fact that the subsidiary could be deemed to be a fixed place of business because of the fact that its premises were used by the Luxembourg company to perform its activity.
However, the Zimmer case shows the limits of this approach. The tax administration had relied on the concept of "fixed place of business" to characterise the permanent establishment of the British company. This proved to be wrong, as the Conseil d'Etat found that Zimmer SAS used its offices and employees for the sole purpose of carrying on its own Commissionaire activities. They could therefore not be analysed as a mere place of business of the British company.
The legal standpoint adopted by the Conseil d'Etat seems to reveal once again the primacy of the civil approach over a purely economic (and sometimes superficial) one. Practitioners will certainly appreciate this valuable contribution to legal certainty. They will nevertheless not find all the answers to their questions in the Zimmer ruling.
The Zimmer judgment raises a number of issues which cannot be tackled entirely in this article. For instance, French tax lawyers must now try to reconcile this decision with a former "Interhome" decision of the Conseil d'Etat, which had stated that a French subsidiary may be treated as a permanent establishment of its parent where it habitually exercises, legally or factually, an authority to bind the parent company to a commercial relationship relating to the operations which constitute the activities of the latter itself(9). The authors have also attempted to show that both the judgments are not contradictory(10).
Other open questions of a higher interest for non-French lawyers may also be mentioned. Indeed, the Zimmer judgment provides that a Commissionaire may exceptionally constitute a permanent establishment where the agency contract was wrongly characterised by the parties. What does this mean in practice? Another issue raised by the judgment is to combine the "permanent establishment approach" of Commissionaires with the "transfer pricing approach" of distribution schemes.
Recharacterisation of the agency contract
According to the Conseil d'Etat, the Commissionaire is not a permanent establishment of the principal "except if the wording of the commission contract or any other factual element of the case implies that, notwithstanding the characterisation of Commissionaire contract chosen by the parties, the principal is personally bound by the contracts concluded with third parties by the Commissionaire who must, under such circumstances, be regarded as its representative and constitute a permanent establishment". It stems from this sentence that the principal bears the risk that the contract be characterised in a different way by the tax authorities. The commission contract does not differ in this respect from any other contract whose legal nature should always be discovered in order for the contract to be subject to its appropriate tax regime.
This being said, it is difficult to predict the kind of circumstances where a Commissionaire contract will be successfully recharacterised by the tax authorities. One may certainly not exclude the possibility of an awkwardly drafted contract where the Commissionaire could actually make it possible for the client to sue the principal directly in case of a breach of contract. One may always imagine a situation where the Commissionaire wrongly writes to his clients that the principal is also liable to them. It is however obvious that such situations and similar ones are highly unlikely to arise frequently in practice. The tax administration's authority to recharacterise commission contracts therefore seems to be severely restricted.
However, contract drafters should always remain cautious as some specific distribution contracts, which are designed to create similar economic effects to those triggered by agency contracts, could well give rise to discussions with tax authorities.
"Permanent establishment approach" and "transfer pricing" approach
The Advocate General before the Conseil d'Etat had rightly pointed out that the permanent establishment concept could not be used by tax authorities as a substitute to transfer pricing rules in order to levy taxes upon foreign companies. While distribution schemes may sometimes make it difficult for administrations to assess the correct taxable basis, legal tools should be implemented properly.
The Supreme Court having found that there was no permanent establishment in the Zimmer case, it is only natural that the Court does not provide for any hints regarding the way profits should be allocated to a PE where the latter is deemed to exist. However, the very fact that the Court came to a negative conclusion concerning the existence of a PE creates a somewhat strange paradox for practitioners. According to well-established standards, Commissionaires and transparent agents are often allocated the same remuneration: in many cases, their functions are very similar and they bear a low level of risk since they do not own the goods which are transferred to the clients and do not suffer any insolvency risk (unless the contract provides otherwise). However, while a transparent agent is likely to be treated as a permanent establishment of the principal, a Commissionaire is not because of the clear statements of the Conseil d'Etat in the Zimmer case. As a result, a distribution scheme involving a transparent agent will create a tax obligation upon the foreign company in addition to the tax burden affecting the local agent's remuneration. This will not be the case if the distributor takes the form of a Commissionaire. The paradox is materialised by the fact that the same functions and risks performed in France will trigger more French taxes if the transparent agent scheme is chosen.
The only rational way to escape this paradox is to decide that profits which should be connected to the authority to conclude contracts which are binding for the principal (as in the case of a transparent agent) should be close to nil. If that was the case, the characterisation of the agent as a permanent establishment would produce no or virtually no financial effect. However, the discussion on the method to be used in order to allocate profits to a dependent agent PE is still very controversial, as the OECD's efforts over the last years have shown. T
his may explain why tax authorities will tend to focus increasingly upon the transfer pricing approach rather than upon the permanent establishment concept in the future. The key issue in this respect will be to determine the arm's length remuneration of distributing companies operating in their host states. Unsurprisingly, the French legislator has recently introduced new transfer pricing documentation obligations for companies which are applicable since January 1, 2010(11), thereby enabling the tax authorities to collect additional information in this respect although it is not fully clear whether the new provisions apply to the relationship between the head office of a company and its branch located in another country. Considering this new context, one may anticipate warm debates in the years to come.
1 The French Council of State. 2 Conseil d'Etat, March 31, 2010, no. 304715 and 308525. The text of the judgment may be found at http://www.legifrance.gouv.fr.3 Administrative court of appeal of Paris, 2 February 2007. 4 See J.-L. Pierre, Droit des sociétés 2007, comm. 125 ; S. Gelin, "Death of a salesman", of the French commissionnaire under attack, BNA International, May 31, 2007 ; D. Gutmann, « La filiale commissionnaire : un établissement stable ? », in Ecrits de fiscalité de fiscalité des entreprises, Etudes à la mémoire du Professeur Cozian, Litec, 2009, p. 547 ; G. Blanluet, , « Le commissionnaire, un établissement stable du commettant ? », Revue de droit fiscal 3/2010, no. 79. 5 Article 94 of the former Commerce code, now art. L. 132-1 of the Commerce code. 6 J. F. Avery Jones and D. A. Ward, Agents as Permanent Establishments under the OECD Model Tax Convention », European Taxation, May 1993 p. 154; comp. S. I. Roberts, « The Agency Element of Permanent Establishment: the OECD Commentaries from the Civil Law View », European Taxation, March 2008, p. 107. 7 OECD Commentary on Article 5, § 41 and 41.1. 8 CE, no. 307235, March 12, 2010, Société Imagin'Action. 9 CE, Sect., June 20, 2003, RJF 10/03, no. 1147; Int'l Tax L. Rep. 1001, 1023 (2003) (English translation). On this topic, see J.-P. Le Gall, The David R. Tillinghast Lecture. Can a Subsidiary Be a Permanent Establishment of its Foreign Parent? Commentary on Article 5, par. 7 of the OECD Model Tax Convention, Tax Law Review, vol. 60, no. 3, 2007, p. 179. 10 Feuillet rapide Francis Lefebvre, 18/2010, April 9, 2010, p. 5. 11 Article L. 13 AA Livre des procédures fiscales.
For further information on this French tax analysis and thought, please contact: Stéphane Gelin, Partner
Daniel Gutmann, Of Counsel