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By a ruling on December 11, 2020, the French Council of State made a significant change to the concept of permanent establishment, a notion that determines the country in which a company is taxed. The judges overturned a decision by the Paris Court of Appeal from March 1, 2018, which had concluded that there was no permanent establishment under the tax treaty between France and Ireland. With this decision, the Council of State clarified the notion of permanent establishment by ruling against the Irish subsidiary ("Irish Co") of an American group.
This decision will impact the activities of international companies operating in France. Indeed, foreign groups are subject to the French tax framework – corporate taxes and VAT – only if their activities in France meet the criteria of a "permanent establishment." In some cases, they will need to be vigilant about the autonomy granted to their agents and subsidiaries and implement strict validation processes.
An Extensive Interpretation of the Concept of Permanent Establishment
An Irish company, a subsidiary of an American group and a sister company of a French firm, carried out digital marketing activities across Europe. These activities mainly involved selling marketing, advertising, and technology services in European markets. The French entity was compensated by the Irish entity on a cost-plus basis of 8% for various services, including administrative, marketing, and representation activities such as client identification, prospecting, and targeting in the French market. All contracts concluded with French clients were signed by the Irish entity.
The Council of State determined that the French entity should be considered a dependent agent in France of its Irish sister company, even though it had not formally concluded contracts on behalf of the Irish entity. In practice, the French company had decided to enter into transactions, which the Irish company simply and systematically approved, making them legally binding for the Irish entity.
It is important to note that, for the first time, the Council of State:
- Rules on the existence of a permanent establishment based on the "dependent agent" criterion regarding a digital actor.
- Uses the OECD comments published after the signing of an applicable tax treaty to support its arguments.
This decision may exacerbate a trend that has been emerging for several years: the French administration's extensive interpretation of the permanent establishment concept, confirmed by the Council of State.
The OECD BEPS Multilateral Convention: A Supranational Tax Treaty?
This ruling also results in the unilateral application by France of an extensive interpretation of the permanent establishment definition under Article 12 of the OECD Multilateral Instrument (MLI) (a treaty adopted unconditionally by France). With this multilateral convention, the French authorities' stated aim was to automatically (and thus more quickly than through bilateral treaty renegotiations) modify the corresponding clauses within bilateral treaties signed with states, based on the absence of mutual reservations and ratification by the states. In France, the MLI was ratified in September 2018 and came into effect on January 1, 2019.
Thus, this treaty has applied to many foreign companies with operations in France. Since its implementation in French law, RSM recommends that its foreign clients remain vigilant, particularly regarding the management of agents operating in France.
Article 12 MLI: Focus on the Role of Agents
One of the measures adopted (Article 12 of the MLI) broadens the cases in which agents constitute permanent establishments. From now on, a dependent agent can also constitute a permanent establishment if they regularly play a predominant role in concluding contracts that are entered into without substantial modification by the foreign company.
Since the Council of State's ruling on December 11, 2020, the risk of an agent's activities being reclassified as a "permanent establishment" subject to taxation in France is real. The stakes are even higher, as having an undeclared permanent establishment may constitute "hidden" activity, which could lead to a penalty of 80% on back taxes and automatic referral of the case to the prosecutor’s office in the event of tax fraud, as outlined in the anti-fraud law of October 23, 2018.
Given the broad application of the decision (i.e., not limited to digital activities), international groups with operations in France should reconsider their operational models in light of this ruling. This analysis should be done on a case-by-case basis, particularly considering the potential modification introduced by the MLI to the conventional definition of dependent agent, depending on the status of reservations and the progress of the MLI ratification process in the other state.
Our teams can assist you in securing your business model in accordance with this jurisprudence.
