A Note on the Zimmer Case and the Concept of Permanent Establishment

J. Clifton Fleming, Jr.

I. II. III. IV. Introduction Electivity Potential Impact on Other Jurisdictions Conclusion

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I. Introduction
The facts and holding of the Zimmer case have been clearly stated and analysed in the preceding paper by Stephne Gelin. Thus, it is sufficient in this paper to merely say that Zimmer SAS was a French commissionaire whose sole activity was selling the products of Zimmer Ltd, a UK company, into France. Zimmer SAS had no inventory. Its activity was limited to soliciting and negotiating orders which became binding contracts between Zimmer SAS and the French customers but which were not legally binding on Zimmer Ltd. The French Conseil dEtat held that (1) Zimmer SAS was not a French PE of Zimmer Ltd. under the dependent agent provisions of Article 5.51 of the France U.K. income tax treaty (substantially identical to the OECD Model) because French domestic law governing commissionaires provided that sales contracts which Zimmer SAS made were not legally binding on Zimmer Ltd. and (2) Zimmer SASs French place of business was not a PE of Zimmer Ltd under the generic provisions in Article 5.12 of the Treaty (substantially identical to the OECD Model) because Zimmer SAS was carrying on its own business, not Zimmer Ltd.s business, in France.3

II. Electivity
The language in Article 5(1) suggests that a taxpayer has a PE whenever objective criteria are satisfied and that there is no element of taxpayer choice. The Zimmer decision, however effectively allows a taxpayer selling into France to choose whether to avoid a French PE or to have a French PE merely by electing to either distribute its goods in France through a commissionaire or through a dependent agent who makes contracts that are binding on the foreign seller.4 In terms of
5. Notwithstanding the provisions of paragraphs 1 and 2, 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. 2 For the purposes of this convention, the term permanent establishment means a fixed place of business through which the business of an enterprise is wholly or partly carried on. 3 For commentary, see L.A. Sheppard, Narrowing Permanent Establishment, Tax Notes 131 (2011): 343; N. Ayme, Commissionaire Arrangement Not a PE, Supreme Court Says, Tax Notes International 58 (2010): 112. 4 For example, a taxpayer who has losses from certain activities in a source country might wish to operate a separate profitable activity through a PE in that country in order to make use of the losses for source country tax purposes and then might wish to convert the separate activity to a non-PE operation once the losses have been used up.
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economic substance, the difference between these two approaches is virtually meaningless but the Conseil dEtat has given them dramatically different consequences and left the taxpayer free to choose between those consequences. There is a suggestion in the Conseil dEtats Zimmer opinion that if the foreign seller regularly performs the contracts negotiated by the commissionaire, then the latter could be held to de facto legally bind the foreign seller and constitute a PE. But the Conseil dEtat was unwilling to use this approach to find a French PE in Zimmer even though Zimmer Ltd apparently accepted and performed virtually all of the contracts negotiated by Zimmer SAS. Consequently, it seems difficult to believe that a French commissionaire will ever be held to create a French PE in any significant number of cases. Since foreign sellers have virtually unlimited legal freedom to choose between a commissionaire structure that does not create a PE and a dependent agent with contracting authority that does create a PE, the existence or not of a French PE is now largely an elective matter.

III. Potential Impact on Other Jurisdictions

It is tempting to regard the Zimmer outcome as a result that is confined to France and to other civil law countries whose domestic law authorizes the commissionaire structure. This temptation should be resisted because Article5(5) of the OECD MC seems to allow a foreign seller to avoid having a PE in any source country if the foreign seller acts through either an independent agent in the source country or through a source country dependent agent who solicits orders that do not become binding contracts until accepted by the foreign seller. One can argue that the independent agent structure is so different from the commissionaire structure that the two are not comparable. I would reply that in terms of economic substance, the difference between these two arrangements is insignificant but for the present, I will pass over that debate in order to focus on the dependent agent structure. The economic differences between a commissionaire arrangement and a limited dependent agent that has authority to obtain orders that do not become legally binding until accepted by the foreign principal are truly insignificant. Most importantly, Article 5(5) of the OECD MC seems to provide that both structures prevent the foreign seller from having a PE in the source country. Thus, in countries whose domestic law does not contain the commissionaire form of organization, there is a strong argument that foreign sellers can effectively achieve the commissionaire result (no PE) by selling through a limited authority dependent agent that is thoroughly controlled by the foreign seller but that merely solicits orders that do not become binding contracts until accepted by the foreign seller.5 And because
5

There have been a few cases holding that the activities of an agent can constitute a PE with respect to a foreign principal even if the agent has no authority to enter into binding contracts in behalf of the principal. See Italy, Court of Cassation, 9 Apr. 2010, No. 8488; F. Zimmer, Norwegian Court Sides with Tax Authorities in Dell, Tax Notes International

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the difference between a dependent agent who lacks the authority to enter into binding contracts (no PE) and a dependent agent who has such authority (a PE) is apparently totally controlled by the language that the foreign seller chooses to include in the agency contract, the issue of PE or not would seem to be as fully elective in non-commissionaire countries as in commissionaire countries. Granted, paragraph 32(1) of the OECD Commentary says that a dependent agent will be deemed to legally bind the foreign seller where the latter routinely approves the contracts procured by the limited authority dependent agent. However, it would seem that this problem can be avoided by the foreign seller reserving real discretion regarding orders procured by the agent, such as where the foreign seller does the credit investigation of the customer instead of delegating that function to the dependent agent. Thus, it seems likely that foreign sellers can use the limited authority dependent agent to create substantially the same results in non-commissionaire countries that they can obtain in France after the Zimmer decision.6 Of course, an agents place of business can be a PE of the principal if the principals business is conducted through the agents business location by means of the agents activities.7 However, in Zimmer the Conseil dEtat held that the agent was carrying on its own business as a commissionaire through its activities, not the principals business. It would seem that the same conclusion would apply to a dependent agent that acted through its own office facilities and employees and was adequately compensated for its work.8
61 (2011), 991; Sheppard, supra note 3. These decisions, however, appear to be outliers. The general understanding is that agent activity can create a PE only when the agent is dependent and has, and habitually exercises, authority to make contracts that legally bind the principal. See OECD Commentary on Art. 5, paras 31, 32, 32(1), 35; US Treasury Department, United States Model Technical Explanation Accompanying the United States Model Income Tax Convention of 15 Nov. 2006, Art. 5(5). 6 Of course, this conclusion assumes that the cases referred to in footnote 5 remain outliers and are not followed in a substantial number of commercially significant countries. 7 OECD Commentary on Art.5, para.10, states: The business of an enterprise is carried on mainly by (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 authorized to conclude contracts if he works at the fixed place of business. However, this language is not applicable when the dependent agent is carrying on its own business of being an agent in facilities that it has procured for itself. For this reason, the Conseil dEtat held that Zimmer SASs offices were not a place of business of Zimmer Ltd. If mere dependency were sufficient to make a dependent agents premises the principals premises also, then Art. 5(5)s requirement that the agent have the authority to enter into binding contracts would be relevant only to dependent agents that lacked an office. While Art. 5(5) clearly applies to such agents, there is nothing that suggests that it is limited to such agents. See OECD Commentary on Art. 5, paras 31, 32. 8 See OECD Commentary on Art. 5(42), which states: Whilst premises belonging to a company that is a member of a multinational group can be put at the disposal of another company 111

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IV. Conclusion
A strong argument can be made that the Conseil dEtats Zimmer decision is not a peculiarity of French law but is instead a French manifestation of the broader point that under Article 5(5) of the OECD MC, foreign sellers are free to avoid PEs in all source countries, including France, by selling through source country dependent agents that lack the authority to enter into contracts that legally bind the foreign seller. For those who believe that source taxation is a bad thing, these observations are good news. But those, like myself, who favour robust source taxation will see the preceding analysis as an additional reason why the PE concept contained in the OECD MC provides an unsatisfactory basis for setting the threshold at which source taxation becomes applicable to business income.

of the group and may, subject to the other conditions of Article 5, constitute a permanent establishment of that other company if the business of that other company is carried on through that place, it is important to distinguish that case from the frequent situation where a company that is a member of a multinational group provides services (e.g. management services) to another company of the group as part of its own business carried on in premises that are not those of that other company and using its own personnel. In that case, the place where those services are provided is not at the disposal of the latter company and it is not the business of that company that is carried on through that place. That place cannot, therefore, be considered to be a permanent establishment of the company to which the services are provided. Indeed, the fact that a companys own activities at a given location may provide an economic benefit to the business of another company does not mean that the latter company carries on its business through that location. 112