Permanent Establishment – an Analysis of Article 5 of the OECD Model Tax Convention Permanent Establishment – an Analysis of Article 5 ... Anders Nørgaard Laursen
Post.doc, PhD Anders Nørgaard Laursen, Department of Law, Aarhus University
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Introduction
The concept of Permanent Establishment (PE) is as old as the concept of Double Tax Conventions (DTC) itself and was included in the very first such: the 1899 DTC concluded between Prussia and Austria-Hungary. In fact the PE concept was originally not a tax law concept but originated in the Industrial Code of Prussia in the mid-19th century.1 Despite its age the PE principle continues to play an important role in international tax law, not only within the legal framework of DTCs but also in domestic tax law and EU Tax Law. Many countries, including Denmark, use the PE concept for various tax purposes in their domestic tax laws.2 Denmark, for instance, only levies taxes on non-resident companies’ business income if the taxpayer has a PE in Denmark to which the income can be attributed.3 As for EU law, an extensive case law from the European Court of Justice (ECJ) exists concerning PEs4 and most EU tax directives concern in some manner PEs, inter alia the Merger Directive (2009/133/EC).
1. 2. 3. 4.
See A.Aa. Skaar, Permanent Establishment – erosion of a tax treaty principle, 1st Ed. 1991, p. 72. See J. Sasseville et al, Is there a Permanent Establishment?, Cahiers de Droit Fiscal International, Vol. 94a (2009), 17, 22. See para 1, letter a of § 2 of the Corporate Tax Act. See inter alia C-311/97, Royal Bank of Scotland; C-293/06, Deutsche Shell; Lidl, infra n. 11 and C-157/07, Krankenheim Ruhesitz. The comparison between PEs and subsidiaryis in EU Tax Law is analysed by L.K. Terkilsen, Frit valg af etableringsform – i EU-skatteretlig belysning, 1st Ed. 2010.
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Permanent Establishment – an analysis of Article 5 of the OECD Model Tax Convention5
2.1 Delimitation Danish tax law does not contain a legislative PE definition. Even so, the domestic PE concept is defined in accordance with Article 5 of the OECD Model. This is due to the fact that both administrative guidelines6 and (administrative) case law – including jurisprudence from the Supreme Court7 – has established that the domestic concept of PE is to be interpreted in accordance with Article 5 of the OECD Model.8 This has presumably been the case at least since 1963.9 Similarly, Danish tax treaty policy is based on the OECD Model, hence the definition found in Article 5 will to a wide extent be mirrored in the Danish DTCs.10 In the case law of the ECJ the issue of a PE definition has never been the focal point. However, the EJC has in its case law stated that ‘for the purposes of the allocation of fiscal competence, it is not unreasonable for the Member States to draw guidance from international practice and, particularly, the model conventions drawn up by the OECD’.11 Because the OECD Model seems to be the common denominator Article 5 of the OECD Model was chosen to be the object for analysis in the dissertation. It should be noted, however, that the Interest and Royalty Directive (2003/49/EC) and the Parent-Subsidiary Directive (2011/96/EU) both feature a PE definition that differs from that of the OECD Model. Despite this fact, as the definition found in the OECD Model seemingly continues to play the most preeminent role these departures from the OECD Model in the directives are not addressed in the dissertation.12 5.
The dissertation, which is in Danish, was titled: ‘Fast driftssted – en analyse af artikel 5 i OECD’s modeloverenskomst’. The dissertation was published in 2011 by Juristog Økonomforbundets Forlag under the titel ‘Fast driftssted’ (reviewed by J. Bundgaard in UfR 2012B, 47). 6. See The Legal Guideline 2012-2 C.D.1.2.2. and C.F.3.1.5. 7. See U 1996.532 H. 8. See Aa. Michelsen, International skatteret, 3rd Ed. 2003, p. 234 and N. WintherSørensen, Skatteretten 3, 5th Ed 2009, p. 159. 9. See E. Møller, Dansk rets regler om begrænset skattepligt, RR 1963, 8. 10. Regarding Danish tax treaty policy see S. Ulstrup, Den danske ‘model’-overenskomst, SU 2001, 69. 11. See C-414/06, Lidl Belgium GmbH & Co. KG v Finanzamt Heilbronn, para. 22. 12. See instead B. Larkin, Permanent Confusion? The Role of the PE in the Merger Directive, 32 Eur. Taxn. 9 (1992), 304; D. Weber, The Proposed EC Interest and Royalty Directive, EC Tax Review, 2000, Vol. 9, Issue 1, 15; M. Distaso et al, The Interest and Royalty Directive – A Comment, 44 Eur. Taxn. 4 (2004), 143; E. Zanotti, 44 Eur. Taxn. 11 (2004), 493, and M. Adda, The supposed autonomy of the PE’s definition in EU Tax Law, Fiscalità Internazionale, 2008 (Marzo-Aprile), 155.
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The dissertation is further delimitated to focus primarily on the basic PE provisions in para 1 and 2 of Article 5 and on the secondary provisions of para 5 and 6, the so-called ‘Agency PE’. The provisions regarding ‘Preparatory and auxiliary’ activities in para 4 of Article 5 is analysed to a lesser extent. The special rule for construction sites in para 3 (the ‘construction clause’) is only included where it can clarify the interpretation of para 1 of Article 5. Para 7 regarding related companies is not subject to analysis, but the thesis presupposes that e.g. a subsidiary can indeed constitute a PE for its parent company.13 2.2 Main Findings – Basic Rule PE A verbatim interpretation of para 1 of Article 5 of the OECD Model reveals five prerequisites for a basic definition PE to exist: 1) 2) 3) 4) 5)
a ‘place of business’ that the place of business be ‘permanent’ that the place of business be ‘fixed’, i.e. at a distinct ‘situs’ that the activity carried on be characterized as ‘business’ that the business is carried on ‘through’ the place of business
A sixth prerequisite, which does not appear from the wording of the provision, but indeed becomes clear from the Commentaries to the OECD Model, is that the place of business be at the ‘disposal’ of the non-resident enterprise.14 As for the prerequisite of a place of business, it becomes clear that this term is to be understood very broadly. Not only offices, factories and stores etc. can be considered places of business but even equipment can fulfill the prerequisite.15 In conjunction with the place of business condition in para 1 it is clear, that the wording of para 2 of Article 5, which lists examples of what ‘the term ‘PE’ includes especially’ should be read instead as what the term ‘a place of business’ especially includes. Despites its wording, para 2 is not a deeming provision, and the existence of e.g. a factory in the source country does not mean by default, that the enterprise owning the factory has a PE in the source country. The term ‘permanent’ does not imply that an enterprise’s presence in the source country must be infinite. Indeed in most cases, a six month presence in the source country is sufficient to satisfy the permanence test. In some cases 13. This issue is throughly analysed by J. Wittendorff, Datterselskabet som fast driftssted for dets moderselskab, SR-Skat 2012, 59 (Part I) and 142 (Part II). 14. I.e. the so-called ‘right of use test’, cf. A.Aa. Skaar, op.cit. pp. 153 et seq. 15. See inter alia TfS 1987, 50 LSR and TfS 1988, 388 LSR.
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an even shorter period might be accepted, e.g. if the enterprise had planned a presence of more than six month but – due to unforeseen events – aborts its presence in the source country after only a short period of time. If an enterprise performs activities exclusively in the source country and does so – due to the nature of the activity performed – only for a short period of time it is provided for in para 6 of the OECD Commentary on Article 5, that the permanence test can be met regardless. This, however, does not seem to comply with a natural reading of the word ‘permanent’, which also was the conclusion of the Norwegian Supreme Court in PGS Geophysical.16 That the place of business must be ‘fixed’ does not mean that the place of business must be fixed to the soil. Indeed, if a business place due to its nature is mobile the ‘fixed test’ can be met if the place of business moves within an area seen as a geographical and commercial coherent whole. The enterprise’s activities in the source country must be considered ‘business’ in order for a PE to exist. The concept of ‘business’ falls subject to three delimitations. Fist it must be examined whether the performed activity can be considered ‘business’ as defined in Article 7 of the OECD Model. Second, this activity must not be of a kind, that is exempt from the PE definition, cf. para 4 of Article 5. And finally the activity must be considered ‘business’ in the eyes of the source country. In Danish administrative case law many cases concern the issue of representative offices of foreign enterprises without authority to conclude business contracts. Danish administrative practice has so far been fairly rigid almost by default deeming such activities as ‘preparatory or auxiliary’ regardless of what other tasks the office performs.17 However, recent case law seems to point towards a more nuanced look at the issue from the Danish Tax Authorities.18 The prerequisite that business must be carried on ‘through’ the place of business gives rise to two different sets of problems. The first set of problems is where an enterprise carries on business, but that business is not linked to the establishment in the source country. This might be the case where the enterprise is seeking to – wrongfully – allocate income earned in one jurisdiction to a PE in another – often low tax – jurisdiction. The second set of problems arises where an enterprise carries on business within the jurisdiction of the source country but outside the place of business; while the activity being 16. See Rt. 2004, 957, 968, and F. Zimmer, Høyesterettsdommer i skattesaker 2004, Skatterett 2005/4, 331. 17. See LSRM 1978, 93; TfS 1989, 165 LSR; TfS 1991, 309 LSR; SKM2002.390.LSR and SKM2005.532.LSR and P.E. Hjerrild-Nielsen, Kan salgsvirksomhed være en hjælpefunktion i relation til fast driftssted?, SU 1991, 239. 18. See SKM2011.351.SR and A.N. Laursen, Repræsentant med hjemmekontor – fast driftssted, TfS 2011, 684.
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carried on at the business place is characterized as preparatory or auxiliary. Whether the ‘business through’ test is satisfied in such a case is highly questionable, and in Danish case law the question is likely to be answered in the negative. The sixth and final prerequisite for a PE to exist is that the place of business be at the ‘disposal’ for the foreign enterprise. The problem arises when the enterprise does not itself own nor have any other explicit legal right to use the place of business. Can that place constitute a PE? In Danish literature the issue has so far never been addressed and has only drawn little attention in case law. In a binding rule from the Assessment Board, TfS 1992, 294, a German enterprise had hired a Danish representative to perform business in Denmark. The representative would drive around Denmark visiting costumers but would also use a home office for various activities of a preparatory or auxiliary nature. In the ruling, the Assessment Board stated that since the home office ‘bore no visible signs of the foreign enterprise carrying on business from the home office’ there was no PE. Without referring directly to the ‘right of use’ test, the decision of the Assessment Board seems to be a reference to just that. After the dissertation had been handed in the Tax Administration seemingly change its position completely. In the case SKM2011.351.SR the Tax Board found in a ruling of similar facts as the 1992-decision that the foreign enterprise indeed had a PE.19 Thus, in Danish case law in many instances the ‘right of use’ test is solely a question of factual use of a place of business. This finding – which the present author believes to be a correct interpretation of Article 5 in the OECD Model – has later been further confirmed in administrative case law.20 2.3 Main Findings – Secondary PE Rule Para 5 and 6 of Article 5 are often referred to as the ‘Agency PE’ rule. This terminology, however, may in many instances not be appropriate. In Danish contract law, an ‘agent’ is most often not authorized to conclude contracts on behalf of the principal, and cannot satisfy the prerequisites laid out in para 5 of Article 5. Hence a Danish ‘agent’ will often not constitute an ‘Agency PE’, and due to this fact the term is deliberately avoided in the dissertation. Much of the interpretive doubt arising from para 5 and 6 of Article 5 stems from the different wording of the French and the English version of the OECD Model. Article 5 requires for a PE to exist that a person concludes contracts in the name of the foreign enterprise. From a civil law point of 19. See A.N. Laursen, loc. cit.; J.C. Raaschou, Kommentar til SKM2011.531.SR (SU2011, 238) om fast driftssted grundet hjemmekontor, SU 2011, 225 and J. Wittendorff, International skatteret 2011, SR-Skat 2011, 226. 20. See SKM2012.313.SR and SKM2012.403.SR.
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view, which presumably is what the French version expresses, this is a way of expressing that a PE only exist, if the contracts are legally binding for the enterprise. From a common law point of view, on the other hand, this condition that the contracts are concluded in the name of the foreign enterprise does not make any sense because all contracts concluded by a common law agent are binding for the principal regardless of whose name is on the contract.21 Another issue regarding para 5 is whether the contracts concluded must be legally binding on the principal, i.e. the foreign enterprise, for a PE to exist or if it is sufficient that the contracts are economically binding. Jurisprudence from the French Supreme Administrative Court (Conseil d’État) in Zimmer Ltd.22 seems to point towards a prerequisite of contracts being legally binding as does the recent judgment from the Norwegian Supreme Court in Dell.23 The different wordings of the French and English versions of the OECD Model also results in difficulties when interpreting the interplay between para 5 and 6 of Article 5. As stated, all contracts concluded by a common law agent are binding for the principal. Hence, a ‘broker’ and a ‘general commission agent’ as mentioned in para 6 of Article 5 can indeed satisfy the prerequisites laid out in para 5. The opposite applies to their civil law counterparts mentioned in the French version, i.e. a ‘courtier’ and a ‘commissionaire’; such civil law intermediaries will as a general rule not satisfy the prerequisites of para 5 and thus it is superfluous to explicitly exempt these intermediaries in para 6. That para 6 is superfluous is even implied in para 36 of the Commentaries to Article 5 of the OECD Model. The mainstream interpretation of the interplay between para 5 and 6 of Article 5 is that an intermediary must meet the prerequisites laid out in para 5 and must be economically or legally dependent on the foreign enterprise, cf. para 6, for a PE to exist.24 However, a more controversial interpretation exists. Accordingly, an intermediary that qualifies under para 5 will per se be excluded from ever being considered economically or legally independent and will always constitute a PE. On the other hand, any intermediary that does not qualify under para 5, but may be seen as economically or legally dependent on the foreign enterprise under pa-
21. See See J.F.A. Jones et al, Agents as Permanent Establishments under the OECD Model Tax Convention, 33 Eur. Taxn. 5 (1993), 153, 158. 22. Conseil d’État 31/10 2010, No. 304715. See the unofficial English translation in Int’l Tax Law Reports 2010/12, 739, 769. 23. Rt. 2011, 1581. See also B.J. Arnold, International – Tax Treaty Case Law News, 66 Bull. Intl. Taxn. 4/5 (2012), 252, and A.N. Laursen, Kommissionærer og fast driftssted i lyset af Dell-sagen, SU 2012, 140. 24. See J.F.A. Jones et al, loc. cit.
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ra 6, may constitute a PE based solely on para 6.25 There is no doubt that the latter interpretation of the interplay between para 5 and 6 is highly controversial, however, the OECD has in its recent proposal for amendments to the Commentaries to Article 5 acknowledged that the French and English versions are inconsistent and that amendments to the Commentaries cannot solve the problem.26
25. See S.I. Roberts, The Agency Element of Permanent Establishment: The OECD Commentaries from a Civil Law View (Part One), Intertax 1993/9, Vol. 23, 396; S.I. Roberts, The Agency Element of Permanent Establishment: The OECD Commentaries from a Civil Law View (Part Two), Intertax 1993/10, Vol. 23, 488 and S.I. Roberts, The Agency Element of Permanent Establishment: The OECD Commentaries from a Civil Law View, 48 Eur. Taxn. 3 (2008), 107. 26. See Interpretation and Application of Article 5 (PE) of the OECD Model Tax Convention (OECD, Paris 2011), para 120, p. 39.
