The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.
By Gary D. Sprague, Esq.
Baker & McKenzie LLP, Palo Alto, CA
The recent decision rendered by the Supreme Administrative Court in Paris in the case of Zimmer Limited1 has lifted a cloud over the use of the commissionaire commercial relationship for the sale and distribution of goods, at least in France and hopefully in other civil law jurisdictions that include the commissionaire concept in their commercial law.
A resolution to the Zimmer case has been awaited anxiously by practitioners. For many years, multinational groups have made extensive use of the commissionaire commercial relationship to structure the distribution of goods and services into the European market. This commercial relationship, regulated by the commercial code of those jurisdictions that provide for the relationship, is something of a hybrid that combines elements of both an agency and a distributor relationship. In a disclosed agency where the agent does not have authority to conclude contracts, the sales entity acting as agent represents the principal in exchange for a commission, but the principal enters into the contracts for the sale of goods in its own name and is directly obligated to the customer to perform under those contracts of sale. In a distributor relationship, the sales entity enters into contracts for the sale of goods in its name and is obligated to perform under those contracts, and must purchase from its supplier the goods it resells. The agent earns a commission for its representation services, while the distributor earns a gross profit for its buying and selling activities. The financial statements of the entity acting as agent or distributor will reflect that choice of commercial relationship.
In contrast, under a civil law commissionaire relationship such as that provided under French law, the sales entity is authorized to enter into contracts for the sale of goods in its own name, but for the account of its principal. Accordingly, an entity acting under this commercial relationship will exhibit certain features of the distributor in that it enters into contracts for the sale of goods or services in its own name, and is contractually bound to the purchaser to deliver such goods or services. It also will exhibit certain features of an agency relationship, in that as a matter of commercial law it never takes title to the goods it delivers, and thus on its financial statements it will record only its commission income and not gross sales revenue or cost of sales.
Multinational groups have implemented commissionaire commercial relationships in their distribution structures to achieve various business efficiencies. The structure reduces the number of commercial invoices that must be issued among related entities, and may simplify the determination of transfer prices among the entities. In many cases, the economic relationship between the sales entity and the principal as reflected in a typical commissionaire relationship is a natural manifestation of the group's regional business model, such as in cases where the group has adopted a centralized model that collects regional manufacturing or sales management in a single entity, which entity also directs sales operations in several jurisdictions in the region. For U.S. groups, the fact that a sales entity operating under a commissionaire relationship does not take title to goods it delivers means that, for Subpart F purposes, the principal is not making sales to a related party when the goods are delivered to third parties through a sales entity operating under a commissionaire contract, which can be helpful in Subpart F planning.2
The Zimmer case arose under the 1968 income tax treaty between the United Kingdom and France. The relevant provisions of the treaty are the so-called dependent and independent agent paragraphs of Article 4, which read as follows: (4) A person acting in a Contracting State on behalf of an enterprise of the other Contracting State—other than an agent of an independent status to whom paragraph (5) applies—shall be deemed to be a permanent establishment in the first-mentioned state if he has, and habitually exercises in that state, an authority to conclude contracts in the name of the enterprise, unless his activities are limited to the purchase of goods or merchandise for the enterprise.
(5) An enterprise of a Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because it carries on business in that other state through a broker, general commission agent or any other agent of an independent status, where such persons are acting in the ordinary course of their business.
While this text has various differences with the current Organization for Economic Co-operation and Development (OECD) Model Article 5(5) and 5(6), the essential language regarding the critical permanent establishment (PE) determinant that a dependent agent deemed PE can be created if the agent habitually exercises an authority to conclude contracts "in the name of the enterprise" is the same as that contained in the current OECD Model.3
Thus, the plain language of Article 4(4) of the 1968 U.K.-France treaty states that a deemed PE arises only if the dependent agent has and habitually exercises the authority to conclude contracts "in the name of" the principal. That does not happen when a sales entity acting under a commissionaire mandate sells goods, as under that mandate the entity enters into contracts only in its own name. Nevertheless, significant concerns had been raised in many quarters that commissionaire arrangements could create PEs on the basis that the obligation of the principal toward the commissionaire to supply goods—for delivery to the customer (including by drop shipment directly to the customer)—that have been sold by the commissionaire could be regarded as falling within the relevant dependent agent paragraph.
Those concerns were heightened when the Administrative Tribunal of Melun, in a judgment rendered on January 27, 2005, concluded that Zimmer SAS, operating as a commissionaire for its principal Zimmer Ltd., a U.K.-established entity, caused Zimmer Ltd. to have a PE in France under the U.K.-France Income Tax Treaty. That decision was affirmed by the Court of Appeals of Paris in a decision dated February 2, 2007. The Court of Appeals concluded that Zimmer SAS comprised a dependent agent with the authority to conclude contracts in the name of Zimmer Ltd., within the meaning of Article 4(4) of the treaty, on the basis that the authority given to Zimmer SAS under the commissionaire agreement created "the result … that Zimmer SAS could bind Zimmer Ltd…. ," and the fact that Zimmer SAS could not "actually conclude contracts in the name of its principal, has no bearing on the company's ability to bind its principal in trading relationships related to the activities of the principal…."4
The Supreme Administrative Court reversed the Court of Appeals decision in its judgment rendered on March 31, 2010. The Supreme Administrative Court adopted a straightforward reading of the treaty, in light of the applicable commercial law.
The Court first referred to the applicable law under which Zimmer SAS operated. Pursuant to the commissionaire provisions as then in effect, a commissionaire is described as "a person who acts in its own name or under a company name on behalf of a principal." Based on that observation, the Court concluded as a matter of principle as follows:[I]t results from these provisions that contracts concluded by a commissionaire, even while they are concluded on behalf of the principal, do not bind directly the principal toward the co-contracting party of the commissionaire; therefore, the commissionaire shall not in principle constitute, only because of the fact that pursuant to the commissionaire agreement it sells, while concluding contracts in its own name, the products or services of the principal on behalf of the latter, a permanent establishment of the principal… .
The Court noted one caveat to this conclusion, stating that the result could be different if due to:either the terms of the contract or any other element of the enquiry, that despite the parties' qualification of their contract as "Commission", the principal is personally engaged by the contracts concluded with third parties by its Commissionaire who shall thus be regarded as its representative and constitute a permanent establishment… .
Turning to the facts of the case at hand, the Court considered the record regarding the activities of Zimmer SAS acting as commissionaire of Zimmer Ltd., and concluded that no PE existed, as the lower court had failed to accept that, as commissionaire, Zimmer SAS "acted in its own name and could not therefore effectively conclude contracts in the name of its principal…."
The Supreme Administrative Court is the highest court in France on this matter. Therefore, no further appeals are possible.
In addition to this statement of principle, there are several other aspects of the case worth noting.
First is the caveat that the general principle would not apply if the contracts concluded with third parties by a commissionaire caused the principal to be "personally engaged" toward the third-party purchaser. This caveat, however, seems only to restate the essential point of the Court's conclusion, namely, that the result could be different if the principal were directly obligated toward the customer as a matter of commercial law.
Second, the court expressly noted that its decision was not affected by the facts that the "sole business" carried out by Zimmer SAS was acting as a commissionaire for Zimmer Ltd., the sales were carried out on behalf of and at the risk of Zimmer Ltd., Zimmer Ltd. bore the costs of marketing, and Zimmer Ltd. controlled most of the general conditions of sale. Accordingly, even though Zimmer SAS was dependent upon Zimmer Ltd., that fact did not give rise to a determination that Zimmer Ltd. had a deemed PE within the meaning of the treaty.
This discussion in the opinion is welcome, as commissionaire structures are frequently used in business models where regional sales management with authority to set terms of trade for a region is centralized in a single entity. In those structures, organizing the sales entities as commissionaires is particularly appropriate, as the normal functional profile of a commissionaire is consistent with the normal allocation of responsibilities in these regional structures. This decision expressly states that using a commissionaire as an integral part of such a distribution model does not create a PE, under the specified conditions, even though the sales entity may constitute a dependent entity of the principal.
Third, the Court also rejected a second theory advanced by the tax authorities, namely, that Zimmer Ltd. had a "basic rule" PE in France based on having a fixed place of business in France. The authorities had argued that the premises and staff of Zimmer SAS constituted an office creating a fixed place of business of Zimmer Ltd., within the meaning of paragraphs 1 and 2 of Article 4 of the treaty. The Court concluded that the premises and staff of Zimmer SAS were at the disposal of Zimmer SAS for purposes of conducting its business as a commissionaire (i.e., not at the disposal of Zimmer Ltd.), and thus did not constitute a fixed place of business of Zimmer Ltd.
This conclusion also is welcome, as it emphasizes the point that an entity may provide services for another enterprise, and may do so for the benefit of and at the risk of that enterprise, and may even do so as a dependent entity of that enterprise (albeit without contract conclusion authority), yet such a commercial arrangement still may not constitute a PE. This point is relevant in contexts other than sales of goods through commissionaires, as the same principle should be maintained in the context of affiliates providing sales representative services, management services, research and development services, and any other similar support function.5
The Zimmer case is not the only commissionaire case to reach a judicial determination. In a case decided in 2002, the Circuit Court of Mexico held that a Mexican affiliate of a Swiss supplier created a deemed PE of its principal in Mexico under Article 5(7) of the Switzerland-Mexico Income Tax Treaty.6 The principal conclusion was that the Mexican affiliate created a PE on the basis that while it constituted an independent agent of the Swiss affiliate, it acted outside the ordinary course of its business. The Court concluded that this fact created a PE under Mexican domestic law and the treaty. This interpretation of the independent agent paragraph of the treaty is an unusual approach, as most commentators would accept that even if the source country agent does not enjoy PE protection under the independent agent paragraph, there still needs to be a showing as to why a PE arises under other provisions of the PE article. It remains to be seen whether this decision will have influence outside of Mexico.
Does the Zimmer decision completely lift the PE cloud over commissionaire structures, at least in Europe? Strictly speaking, the precedent applies only in France, and the case in Mexico shows that other national courts could come to a different conclusion. Nevertheless, the Supreme Administrative Court's reasoning involves a straightforward application of the language of the treaty to the normal commercial relationships established under a commissionaire arrangement. In the area of treaty interpretation, courts, at least in some jurisdictions, will consider the jurisprudence of other jurisdictions that have considered the same or similar issue. This issue is one which would be particularly appropriate for uniform application across jurisdictions. The essential elements of the commissionaire relationship on which the Court relied commonly exist in all civil law jurisdictions that authorize the commissionaire relationship. The treaty language that the Court interpreted also is common to all treaties that are based on the OECD Model. There is no unique policy context at play in the Zimmer case, which could distinguish this case from other typical commissionaire structures. Accordingly, it can be hoped that this decision will allow multinational groups to once again choose for their goods and services the distribution structure that is most appropriate for their allocation of contracting and sales management functions, without fear that unexpected PE assertions could limit their ability to implement rational distribution structures.
This commentary also will appear in the July 2010 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.
2 Note that different considerations may come into play if the commissionaire is selling services, licenses, or rental agreements, as in those cases there is no local statutory equivalent in most jurisdictions to the provision that the commissionaire does not take title to the goods it sells as might be relevant to services, license, or lease transactions.
3 The U.S. Model (2006) uses different language in Article 5(5), as it refers to agents which habitually exercise an authority to conclude contracts "that are binding on the enterprise…." The Technical Explanation to Article 5 of the U.S. Model provides the following explanation: "The OECD Model uses the term `in the name of that (sic) enterprise' rather than `binding on the enterprise.' This difference is intended to be a clarification rather than a substantive difference. As indicated in paragraph 32 to the OECD Commentaries on Article 5, paragraph 5 of the Article is intended to encompass persons who have `sufficient authority to bind the enterprise's participation in the business activity in the State concerned.'"
5 See, for example, paragraph 42 of the OECD Commentary on Article 5, noting that the premises of an entity providing services to a group member does not constitute a PE of the service recipient when the entity providing services is using its own premises and personnel to carry on its own business.
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