In a decision dated Dec. 11, 2020, the French Administrative Supreme Court (Conseil d'Etat) overturned a Paris Court of Appeal decision dated March 1, 2018 (which had previously concluded in the absence of a permanent establishment under the France-Ireland Tax Treaty) and ruled against the Irish subsidiary (Irish Co) of a U.S. group. In this decision, the Conseil d'Etat expanded the definition of a permanent establishment, a concept that determines tax jurisdiction.
Irish Co, a subsidiary in a U.S. group and sister company of a French corporation (French Co), carried on digital marketing activities (mainly consisting of selling marketing, media and technology services) in Europe. Irish Co remunerated the French Co on a cost plus 8% basis for various services including administrative and marketing activities and representation. The Irish entity signed all contracts concluded with French clients.
The Conseil d'Etat ruled the French Co should be considered a dependent agent of Irish Co, even if it did not formally conclude contracts in the name of Irish Co. The Conseil d'Etat reasoned that since the French Co decided on transactions that the Irish Co systematically approved, it became legally binding on the Irish Co.
Comments and conclusions
It is important to note this is the first time that the Conseil d'Etat has ruled on the existence of a permanent establishment based on the dependent agent test in respect to a digital player, and used OECD comments in support of its arguments.
This decision will create a precedent in France and will result in the unilateral application of an expansive interpretation of the definition of permanent establishments under Article 12 of the Multilateral Instrument (MLI) adopted by France. By way of reminder, in November 2016, over 100 jurisdictions concluded negotiations on the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting that was created to swiftly implement a series of tax treaty measures to update international tax rules and lessen the opportunity for tax avoidance by multinational enterprises. Signed in Paris in 2017 by 88 jurisdictions, including France (the United States has not signed it as of the publish date of this piece), the MLI is intended to modify automatically – and therefore more rapidly than a bilateral renegotiation of conventions – the corresponding clauses of existing bilateral conventions on the basis of an absence of reciprocal reservations and ratification by States. The MLI was ratified in France in September 2018 and entered into force on Jan. 1, 2019.
One of the measures adopted (article 12 of the MLI) expands the cases in which agents constitute permanent establishments by stating a dependent agent may constitute a permanent establishment if the dependent agent plays a predominant role in the conclusion of contracts that are entered into without material modification by the foreign company.
Article 12 is subject to the provisions of a covered tax agreement that define the term permanent establishment. This article is also subject to paragraph 2, which covers a person acting in a contracting jurisdiction subject to a covered tax agreement on behalf of an enterprise. Under this provision, if such a person habitually concludes contracts, or habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise, and these contracts meet the following criteria, a permanent establishment may have been created:
The contracts must be
- in the name of the enterprise; or
- for the transfer of the ownership of, or for the granting of the right to use, property owned by that enterprise or that the enterprise has the right to use; or
- for the provision of services by that enterprise, that enterprise shall be deemed to have a permanent establishment in that contracting jurisdiction in respect of any activities which that person undertakes for the enterprise unless these activities, if they were exercised by the enterprise through a fixed place of business of that enterprise situated in that contracting jurisdiction, would not cause that fixed place of business to be deemed to constitute a permanent establishment under the definition of permanent establishment included in the covered tax agreement (as it may be modified by this convention).”
Under French law, undeclared permanent establishments can be characterized as the exercise of a ‘hidden’ activity likely to result in a penalty of 80% and an automatic transmission of the file to the Public Prosecutor's Office under the law relating to the fight against fraud of Oct. 23, 2018, in the context of tax fraud proceedings.
A key takeaway is that the recent decision is broad in its application and is not limited to digital activities. International groups with activities in France should review their operating models in light of this decision.
Reporting entities should consider the implications for their global income tax provisions. If the enterprise has confirmed the existence of a branch, consider whether a current tax liability in the host jurisdiction will affect the current tax liability in the head office jurisdiction, such as through foreign tax credits. Assets used in the branch may have tax basis for both host country and head office jurisdictions, leading to deferred tax assets or liabilities in both jurisdictions with interplay between the two to the extent there are offsets like foreign tax credits. Reporting entities should also consider the need to record a liability for an uncertain tax benefit (UTB) for unrecognized branch liabilities in the current and past years. The UTB should take into account the full scope of implications, including host and head office current and deferred tax implications, and the exposure for penalties and interest.
U.S. multinationals should also make note of this ruling as it relates to reporting branches on Form 8858, Information Return of U.S. Persons With Respect to Foreign Disregarded Entities (FDEs) and Foreign Branches (FBs). A permanent establishment is a deemed branch for U.S. tax purposes and therefore required to file Form 8858. If a controlled foreign corporation (CFC) owns the branch, there could be substantial penalties as well as the potential loss of foreign tax credits for the failure to file Form 8858.