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By Gary D. Sprague, Esq. Baker & McKenzie LLP Palo Alto, California
In previous commentaries, I have reported on controversial cases considering the question of whether sales effected through a civil law commissionaire should be regarded as creating a deemed permanent establishment (PE) of its principal under treaties that conform to the Organization for Economic Cooperation and Development Model Tax Convention (OECD Model). The Supreme Court of Spain has now rendered its decision in one of those cases, concluding that sales effected through Dell España SA as commissionaire appointed under article 246 of the Spanish civil code created a PE of its principal, Dell Products Ltd., an Irish company. The Court expressly recognized that its decision conflicted with prior decisions on the same issue by the Supreme Courts of France and Norway.
The Spanish decision is notable in two aspects beyond the scope of the interpretation of the deemed PE rule of Art. 5(5), which is the normal context of the issue of whether a commissionaire creates a PE.
First, the Court initially found a PE based not on the dependent agent rule of Art. 5(5), but on the basis of a “fixed place of business” under Art. 5(1), even though the principal did not occupy any premises in Spain through its own employees. This interpretation of the Art. 5(1) rule has implications far beyond the scope of commissionaire structures.
Second, the Court rejected a literal interpretation of the dependent agent paragraph in Art. 5(5) in favor of an analysis based on “the functional-economical-material doctrine,” which the Court employed to reach a result that it concluded was more in line with the purpose of the Treaty, in light of the new “global commercial scenario.” This approach conceivably has implications across a wide range of treaty interpretation issues, as it is a notable departure from the normal principles of treaty interpretation as developed under the Vienna Convention on the Law of Treaties.
From the case report, it appears that the Spanish sales organization operated in much the same way as in other groups which have structured their local sales entities as commissionaires. The Spanish entity promoted the products of its principal, concluded sales, managed orders, provided marketing and advertising services focused on the Spanish market, provided warehousing and logistics services, managed credit reviews of customers, and monitored receivables. Some of these functions also were performed by the principal. As is normally the case in a commissionaire relationship, the sales contracts were entered into solely in the name of the Spanish entity, although the contracts were for the benefit of the principal.
The Court commenced its analysis by noting that the Treaty constituted the governing law. Under the Spanish Constitution, the Treaty prevails over domestic law. The Court further directly stated that the Treaty should be interpreted according to the OECD Model Commentary. The Court also logically concluded that where an issue had been raised under the separate theories of a “fixed place of business” (FPOB) under Art. 5(1) and a deemed dependent agent PE (DAPE) under Art. 5(5), then it was appropriate to analyze the FPOB issue first. The Court considered the DAPE test to be secondary to the FPOB rule, and noted that if an FPOB PE had been identified, it then would be “useless and superfluous” to examine the DAPE issue, “unless it is done for reinforcement.” As it turned out, the Court indeed found a PE under the FPOB rule, but still addressed the DAPE test, also finding a PE under that rule. Whether the Court considered it necessary to develop the DAPE theory for “reinforcement” or some other reason was not explained.
Turning to the technical analysis, the Court cited the relevant provisions of the OECD Commentary relating to when premises are “at the disposal” of a nonresident, namely, paragraphs 4, 4.1, and 4.2 of the Art. 5 Commentary. The Court then also cited paragraph 10 of the Art. 5 Commentary describing those persons who carry on the business of an enterprise, as follows:
The business of an enterprise is carried on mainly by the entrepreneur or persons who are in a paid-employment relationship with the enterprise (personnel). This personnel includes employees and other persons receiving instructions from the enterprise ( e.g., dependent agents). The powers of such personnel in its relationship with third parties are irrelevant. It makes no difference whether or not the dependent agent is authorised to conclude contracts if he works at the fixed place of business….
The Court considered that this Commentary guidance “indicates a high level of flexibility granted to the ‘fixed place of business' expression,” referring initially to the point that the Commentary expressly states that premises can be at the disposal of a nonresident even if the nonresident does not hold a formal legal right to use those premises. In the critical analytical step, the Court then provided the following interpretation of paragraph 10:
…in addition, with the same broad scope, disposal also includes, under the wide interpretation given by the applicable regulations, activity on account of the company.
The Court then noted the following, which appears to be an expression of treaty interpretation that gives license to a court (and tax authorities) to depart from the literal language of a treaty:
Furthermore, given the function and purpose of these Treaties — regulating international taxation issues — one must not lose sight of the new reality and global commercial scenario, which necessarily mean that applicable regulations should be interpreted in light of this new reality, where it is essential to take into account the substance of new forms of business activity.
Viewing the Commentary from this perspective, the Court concluded that there is no requirement for the nonresident to have any actual personnel located on the premises, as the “fixed place” could be found solely due to activities performed by employees of the Spanish affiliate. In reaching this decision, the Court expressly adopted a statement by the lower court that the business activities recited above as performed by the commissionaire should be regarded for treaty interpretation purposes as the business of the nonresident carried on in Spain at the premises of the Spanish affiliate.
This decision has implications far beyond the commissionaire context. In essence, it represents a theory under which any nonresident can be exposed to an FPOB assertion in Spain if it operates through an affiliate where the tax administration can contend that the Spanish affiliate's activity constitutes the nonresident's performance of functions in Spain.
For readers who have followed the prior commissionaire cases, the theories advanced by the taxpayer and the tax administration will be familiar. The taxpayer argued that the literal text of Art. 5(5) precludes application of the DAPE theory to a commissionaire, as the text of Art. 5(5) refers to the dependent person entering into contracts “in the name of the enterprise,” which does not happen in the commissionaire context. The taxpayer further argued that the Spanish entity was an independent agent within the meaning of Art. 5(6).
The Court concluded that a DAPE existed in this case, on the basis of “the functional-economical-material doctrine,” which it found supported the view that the commissionaire activity created a sufficient link between the customer and the principal. Apparently relying on the OECD Art. 5 Commentary at ¶33, the Court stated that there needs to be only a “functional link” between the customer and the principal, so that an agent may be “sufficiently empowered to bind the principal,” even if there is no actual legal authority to do so.
As was the case in the section of the opinion dealing with the FPOB theory, the Court supported its technical analysis with the following statement of treaty interpretation principles:
The foregoing seeks the purpose and aim of fulfilling international taxation regulations, aimed at fairly distributing tax burdens and business profits amongst States, in a very different scenario from the one that existed at the time Double Taxation Treaties arose: a globalized market where multinationals are trying to transfer the profits obtained in other States towards another country with lower tax rates. Consequently, the appellant's strictly formalist-literal and static interpretation is inadmissible, even though at a given moment certain courts in other countries — such as Norway or France, as indicated by the appellant — have used said interpretations of similar Double Taxation treaties to the one at hand.
Action 7 in the OECD/G20 BEPS project directly addressed the Art. 5(5) interpretative issues dealing with commissionaires as raised in this case. Assuming that Spain and its treaty partners agree to amend their treaties to include the Action 7 recommended changes to Art. 5(5), this precise interpretative issue will not arise for years after the treaty changes come into effect. For those future years, taxpayers can expect that use of the commissionaire structure will create a DAPE under the revised Art. 5(5).
The Action 7 recommended revisions did not propose any changes to Art. 5(1). Accordingly, the Court's interpretation of when a nonresident may be regarded as having the premises of an affiliate “at its disposal” is relevant to any case arising before or after the OECD/G20 BEPS Project.
Ultimately, the most troubling part of this opinion lies in the two statements quoted above which illuminate the Court's view of how treaties should be interpreted. In both cases, the Court indicated a willingness to interpret treaties in ways to achieve a policy goal, which would not necessarily be achieved by an application of the literal text of the treaty.
It is a fundamental rule of international law, embodied in the Vienna Convention on the Law of Treaties, that treaties are to be interpreted as contracts between the two Contracting States. As such, the role of the interpreter is to uncover the intention of the Contracting States as to the meaning of treaty text at the time the treaty was negotiated and signed. The plain meaning of the treaty text is always the principal source of interpretation. Where that text leaves the meaning ambiguous in a particular case, the Vienna Convention provides that a court may refer to preparatory works underlying the treaty.
The statements by the Court in this case that it will interpret treaties according to “new realities,” and not by reference to a “formalist-literal and static interpretation,” injects uncertainty into any case where the treaty text or its interpretative materials (such as the OECD Commentary) might be in any way ambiguous. Taxpayers that seek certainty in their tax affairs have reason to be concerned when the highest court of a jurisdiction expresses treaty interpretation principles that consciously disassociate the analysis from the literal text of the treaty.
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