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By Gary D. Sprague, Esq.
Baker & McKenzie LLP, Palo Alto, CA
Readers who follow issues of tax treaty interpretation will know that two cases regarding whether the normal operation of a civil law commissionaire constitutes a deemed permanent establishment (PE) of its principal under tax treaty provisions similar to Article 5(5) of the Organization for Economic Cooperation and Development (OECD) Model Tax Convention (MTC) have been addressed by the courts in France and Norway. The issue has now been decided at the highest level in France, as the Supreme Administrative Court concluded that Zimmer SAS, the French affiliate of Zimmer Ltd., acting as a commissionaire for its U.K. principal, did not constitute a deemed PE under the terms of the U.K.-France treaty.1 In contrast, in Norway, the Borgarting High Court affirmed a decision of the Oslo District Court that Dell AS, acting as commissionaire for its Irish principal, Dell Products Ltd., did constitute a deemed PE of its principal under the terms of the Ireland-Norway treaty.2 The taxpayer has appealed this decision, so there will be another chapter to this Norwegian saga in the near future.
It is always troubling, of course, when two courts reach opposite conclusions on essentially the same legal issue. These cases are particularly significant for international tax practitioners as the courts have come to opposite conclusions with respect to the meaning of paragraph 32.1 of the OECD Commentary to Article 5 as a guide to interpreting Article 5(5) of the MTC in the case of a civil law commissionaire. That Commentary language has become, in recent years, notorious for the controversies it has generated.
The definition of a PE stands at the core of international tax law: when can a source state exercise jurisdiction to tax, on a net basis, the business profits of a nonresident enterprise? Article 5(5) of the MTC provides that one such basis is the so-called "dependent agent" deemed PE, stating as follows:
5. … where a person — other than an agent of an independent status to whom paragraph 6 applies — is acting on behalf of an enterprise and has, and habitually exercises, in a Contracting State an authority to conclude contracts in the name of the enterprise, that enterprise shall be deemed to have a permanent establishment in that State in respect of any activities which that person undertakes for the enterprise, unless the activities of such person are limited to those mentioned in paragraph 4 which, if exercised through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph.3
The issue in both the Zimmer and Dell cases was whether Zimmer SAS and Dell AS, acting in the commercial capacity as commissionaire for their respective principals, exercised an authority to conclude contracts "in the name of" their principal. Under French and Norwegian commercial law, the contracts entered into by an entity acting under the commercial relationship of commissionaire are entered into in the name of the commissionaire, not the principal, and are enforceable by the customer under the law of contract only against the entity which entered into the contract, namely Zimmer SAS and Dell AS. A principal that does not supply product to the commissionaire for delivery under the contract entered into by the commissionaire, is at the risk of being sued for specific performance or damages by the commissionaire. Non-performance under the contract for sale gives rise to contractual claims by the customer against the commissionaire, not against the principal. Product liability claims, of course, may lie against the manufacturer directly under applicable law.
Therefore, this would seem to be a straightforward analysis — the contracts with the customer are only between the local customer and the local legal entity, and thus are not "in the name of" the nonresident enterprise. The tax authorities in both cases, however, argued that paragraph 32.1 of the OECD Commentary to Article 5 supported the proposition that the treaty language should not be applied literally. That Commentary reads in relevant part as follows:
Also, the phrase "authority to conclude contracts in the name of the enterprise" does not confine the application of the paragraph to an agent who enters into contracts literally in the name of the enterprise; the paragraph applies equally to an agent who concludes contracts which are binding on the enterprise even if those contracts are not actually in the name of the enterprise.4
Some background to this sentence is in order. In 1992, the United Kingdom lodged an Observation to the Article 5 Commentary as follows:
The United Kingdom considers that an agent who is not an agent of independent status within paragraph 6 of this Article and who has the characteristics described in paragraphs 32 and 33 above will represent a permanent establishment of an enterprise if he has the authority to conclude contracts on behalf of that enterprise whether in his own name or that of the enterprise.5
The issue addressed in the U.K. Observation is the point that under common law concepts of agency, the contracts entered into by an agent, even if the principal for which the agent is acting is not disclosed to the counterparty at the time of contracting, are contractually binding on the principal, and the counterparty may demand performance directly from the principal once the principal is identified. This is different from the law of commissionaire relationships. U.K. commercial law does not include the commercial relationship of commissionaire, as such exists under the laws of France, Norway, and other civil law jurisdictions.
In 1995, paragraph 32.1 of the Commentary was revised to read as quoted above, and the United Kingdom then removed its Observation. The purpose of the paragraph 32.1 sentence, therefore, was to express a conclusion that arises under the application of common law agency concepts, but apparently was not intended at the time to give guidance on other situations. This provenance seems to be clearly understood; even the Borgarting High Court stated in its opinion that this sentence was added to the Commentary "because of the situation in the common law system, where the principal will be legally bound by the agent's actions regardless of the agent acting in the principal's or its own name."6
Despite that fairly narrow original intent of the first sentence of paragraph 32.1, this Commentary text has been the cause of much mischief in recent years. Tax authorities have endeavored to argue that this language stands for a general license to depart from the literal language of the treaty. This was the case in both Zimmer and Dell, as well as in numerous tax audits of other taxpayers, making paragraph 32.1 notorious as one of the provisions of the Commentary where tax authorities have seen an invitation to assert results based on factors other than an analysis of the relevant commercial law.
The lower court in Zimmer accepted the invitation to look beyond the commercial law, concluding that the fact that Zimmer SAS acted only in its own name and thus did not actually conclude contracts in the name of its principal "has no bearing" on whether the actions of Zimmer SAS could be regarded as binding Zimmer Ltd. under the applicable treaty principles. Similarly, in the Dell case, the Borgarting High Court concluded that paragraph 32.1 means that the treaty "cannot be interpreted literally." It then proceeded to rely on factors such as the fact that the products were sold under the Dell trademark, that the sales terms were standard, and that Dell Products Ltd. in fact shipped products against all orders forwarded by Dell AS as the justification for concluding that a dependent agency PE existed.
The most troubling feature of these analyses is that a court would so readily decline to interpret a tax treaty term by what would seem to be the plain meaning of the treaty language. Certainly it needs to be a principal feature of international tax jurisprudence that treaty terms are to be interpreted by their plain meaning, absent compelling evidence that the original intent of the treaty negotiators was to imbue a different meaning to the language. This principle would seem to be even more important in cross-border relations between states than in the purely domestic context. In the domestic law context, interpretation of a statute may be informed by a rich tapestry of administrative guidance, regulations, and judicial determinations. In the cross-border context, issues necessarily involve the interaction between different legal systems and different tax environments. As a result, the need for clarity arguably is even greater in the cross-border context, and any justification for departures from the plain meaning of the treaty language should be even more compelling.
In the final determination of the Zimmer case, the Supreme Administrative Court took exactly this principled approach. The court noted that the treaty language finds a PE if the agent concludes contracts in the name of its principal, and then observed that the applicable commercial law of France states that the commissionaire is a person which acts in its own name, not in the name of its principal. Through its Rapporteur Public, the Supreme Administrative Court addressed the meaning of paragraph 32.1, as follows:It is, in fact, established that this Commentary has been added at the request of Great Britain in reaction to an English jurisdictional decision which, by literally applying the provisions of the convention, had decided that an agent could be classified as a permanent establishment only on the strict condition that it was actually able to conclude contracts in the name of the foreign enterprise. But in the common law system, an agent can, like the commissionnaire, act on behalf of others while contracting in its own name. For all that, unlike the commissionnaire, this agent can legally bind, in the contractual sense of the term, the person that he represents, even if the latter is not known to the third party—who will have an action against him. Depending on whether or not the represented party is known to the third party, we speak of `disclosed' or `undisclosed agent' but, in both cases, the represented person is legally obligated to the third party, without the contract being concluded in their name (see on this point J Sasseville and Arvid A Skaar, General Report, in `Is there a Permanent Establishment?' Cahiers de droit fiscal international, Vol 94 A, 2009 pp 51 et seq).
In other words, here as well, what matters is whether the represented person is legally obligated, that is to say bound (`to bind' in the English version). This Commentary, the impact of which must be limited to this type of contract peculiar to common law countries, doesn't therefore lead, in our eyes, to the extension of the concept of binding, which can only be in a legal sense.
Consequently, the literal interpretation of the provisions of paragraph 5 of article 5 of the model (a principle of international public law as noted by articles 31 to 33 of the Vienna Convention on the Law of Treaties, see also in particular, 26 July 2006 n° 284930, Ste´ Natexis Banques Populaires RJF 11/06 n° 1421, conclusions of P Collin BDCF 11/06 n° 142) must lead to the exclusion of the commissionnaire from the field of application of the concept of permanent establishment—an exclusion apparently confirmed, as an exception, by para 6.7
The court therefore concluded that the impact of paragraph 32.1 must be limited to such common law contracts, and that the relevant question under French law would be whether the principal was bound as a matter of law. Because the French commercial law answers that question in the negative, the court applied the plain meaning of the treaty to conclude that a PE existed.
There are at least two more bodies to be heard from in the near future. As noted, the Dell case is on appeal. I will not endeavor to predict what the Norwegian Supreme Court will say. I would hope that most observers would recognize that elements relied on by the Borgarting High Court such as the sale of products under the Dell trademark, the use of standard sales terms, and the shipment of products by Dell Products Ltd. against all orders forwarded by Dell AS are in no way an indication that the commissionaire has a legal power to bind the principal. These elements are all ordinary aspects of modern global sourcing, manufacturing, and distribution systems for branded goods, with no bearing on the underlying contractual relationships between the supplier and its commissionaire.
I have more hope for the current OECD project to provide further guidance on certain interpretative issues under Article 5 and the Commentary. The question of how the language "in the name of" should be interpreted has been on the policy table for some time, and is a subject of intense interest among taxpayers. It would be useful for the OECD to clarify the original intent of para 32.1 of the Commentary as presenting an accurate reflection of the law of agency in common law jurisdictions, but to disavow any wider intention that such language allows a departure from the sort of principled analysis shown by the French Supreme Administrative Court. It is to be hoped that the OECD project will support the proposition that this is an area where the plain meaning of the treaty language must be respected.
This commentary also will appear in the July 2011 issue of the Tax Management International Journal. For more information, in the Tax Management Portfolios, see Katz, Plambeck, and Ring, 908 T.M., U.S. Income Taxation of Foreign Corporations, and Cole, Kawano, and Schlaman, 940 T.M., U.S. Income Tax Treaties — U.S. Competent Authority Functions and Procedures, and in Tax Practice Series, see ¶7130, Foreign Persons — Effectively Connected Income, and ¶7160, U.S. Income Tax Treaties.
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