• Tax on digital economy
    A new beginning

    By Shaomei Chen


    In a decision issued on July 12, 2017 by the Paris Administrative Tribunal, the Court found that Google’s advertising-sales business carried on by Google Ireland, did not have a permanent establishment in France and ruled against the 1.11 billion Euro bill sought by the France’s tax authority for five years of back taxes. This decision, which was ruled based on Ireland-France Tax Treaty (1968) exactly reflects the flaws of the current used permanent establishment concept in OECD Model (2014) on tax on digital economy.

    Though Google has a group company established in France, i.e. Google France, that group company did not sell advertising services to French customers directly. Rather, Google Ireland, an Irish resident company did so but without having a place of business in France. Google France offered only logistical and marketing support to Google Ireland and received a service fee. It led to relatively small amount profits left in France, compared to the enormous sales profits earned from the French customers by Google Ireland.

    Current PE concept

    The PE concept used in tax treaties, identical to OECD Model effectively serves as a threshold to determine the circumstances when the non-resident enterprises can be considered to have sufficient ties to a source state in order to justify taxation in that state. Under OECD Model, business profits derived by a non-resident enterprise cannot be taxed in the source state if its activity therein does not meet the threshold of PE.

    The current PE concept comprises of two types of PE: (1) “physical PE”: a fixed place of business through which the business of the enterprise is carried on; (2) “dependent agent PE”: where a person is acting on behalf of the enterprise and has habitually exercise an authority to conclude contracts in the name of the enterprise. Both to some extent require physical presence of the non-resident company in the source state, which is difficult to tackle similar operating structures as Google used in France.

    First, Google Ireland does not have its office or branch in France and generally does not have a fixed place of business itself in France. Even if Google France is a related company of it, it is difficult to argue that the fixed place belonging to Google France could give rise to a physical PE of Google Ireland in light of Art. 5(7) of OECD Model unless it is found that any office of Google France was being used by employees of Google Ireland for its advertising-sales business (See Paragraph 4.3 of OECD Comm. (2014) on Art. 5 and India Rolls Royce Case).

    Answer may be different if Google Ireland processed its sales orders by hosting servers in France. According to the OECD Commentaries, a server operated by the non-resident enterprise may constitute a physical PE if it is located at a certain place for a sufficient period of time, even though no personnel is present in the source state. However, if the enterprise does not operate the server itself but only makes use of the server-storage service provided by an internet service provider (ISP), that server cannot be considered as at the disposal of that enterprise and does not constitute a PE for it (See Paragraphs 42.1 to 42.10 of OECD Comm. (2014) on Art. 5). Even if a server-PE is found in the source state, it is not the end of story. It definitely does not mean that the source state, like France in this case, can tax the large amount profits from the sales activities therein. How much the source state may tax is still based upon the amount of profits attributable to that PE taking into account the functions performed by the server-PE. The current Authorized OECD Approach (AOA) for attribution of profits to PE adopts the test of “significant people function”. In the absence of personnel in the server-PE, the conclusion may be that little or no profits would be attributed to such a PE. Such conclusion is also reflected in the 2010 OECD Report on the Attribution of Profits to PE. So, having a server-PE does not really help the source state in taxing the profits.

    Besides, since Google France has no authority to conclude contracts in the name of Google Ireland, without other personal acting on behalf of Google Ireland present in France, the threshold for dependent agent PE is not satisfied, as well.

    2017 update to OECD Model Convention

    The draft contents of the 2017 update to the OECD Model Convention was released on July 11, 2017, which include changes to Art. 5 (definition of PE) as contained in the BEPS Final Report on Action 7 (Preventing the Artificial Avoidance of PE Status). But the changes are not radical modification to the current PE concept, rather it extends the scope of Art. 5(5) dependent agent PE and makes some changes to Art. 5(4) that regulates exceptions to PE.

    Under the 2017 update, the concept of dependent agent PE in Art. 5(5) will also cover the situation where a person acting on behalf of the enterprise habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise. That means that the person present in the source state does not necessarily conclude the contracts in the name of the foreign enterprise any more. But in view of the logistical and marketing activities carried on by Google France, it is still difficult to say that under the new modification to the current PE concept, Google France played the principal role in the conclusion of advertising-sales contracts as between the French customers and Google Ireland if it was not involved in the contract-related activities, e.g. processing the sales orders and negotiating the main provisions of the contracts, which are not materially modified by Google Ireland. Another change to Art. 5 in 2017 update is to clarify the activities listed in Art. 5(4) as the exceptions for PE are subject to the requirement of being preparatory and auxiliary. This change will not affect the conclusion of this case if Google Ireland simply does not have an Art. 5(1) or Art. 5(5) PE in France in the first place.

    It seems that a stronger test, except for the current PE concept, is needed for the source state to tax these Internet giants that heavily rely on the technology instead of on the physical presence of the personnel.

    BEPS Action 1 – a new nexus in the form of a significant economic presence

    BEPS Action 1 provides a new test to supplement the current PE concept on tax on digital economy, though it was not recommended at this stage by OECD and will not be included in the 2017 update to the OECD Model Convention. Under the new test, a taxable presence would be created in the source state in the absence of physical connection, as long as the non-resident enterprise has a significant economic presence in that state on the basis of factors that indicate a purposeful and sustained interaction with the economy of that state via digital tools. Factors that would be examined include 1) revenue-based factor (e.g. the number of digital transactions with customers from that state), 2) digital factors (e.g. a local domain name, a local digital platform or local payment options) and 3) user-based factors (e.g. the number of monthly active users from that state on the digital platform). Rules on profits attribution would also need to be changed to be consistent with the new test, since the current AOA approach focuses too much on the functions performed by personnel with the principle of “significant people functions”.

    It is very likely that some EU countries, like France, will endeavor to push the implementation of the new test within EU or to develop a similar measure to combat the structure used by the digital companies. This can already been seen from a statement by Austrian Finance Minister released following his meeting with French Finance Minister on July 30, 2017, which said that Austria would prioritize measures to combat tax avoidance, including proposal on “virtual” permanent establishment during its presidency of the European Union in the second half of 2018. The new test may also be applied in the proposals for Common (Consolidated) Corporate Tax Base (C(C)CTB), which is now being considered at the Council of Europe and European Parliament. The draft report by European Parliament on CCTB proposal released on July 13, 2017 has also contained a similar provision as the new test in BEPS Action 1 to define digital presence in the article on permanent establishment in another Member State. More changes towards the new test can be expected, and it may at the end lead to radically different tax rules being adopted for tax on digital economy, compared to the current international tax rules.

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  • The information provided in this article is for general information purposes only. The information is not intended to be comprehensive or to include advice on which you may rely. You should always consult a suitably qualified professional on any specific matter.

Shaomei Chen

Shaomei Chen is a PhD researcher in the Research Program of Limits of Tax Jurisdiction at Leiden University, the Netherlands. She is writing her PhD thesis in Tax Treaties. Shaomei completed her Adv. LL.M. in International Tax Law with summa cum laude at International Tax Center of Leiden University. After that, she served as teaching assistant in 2016 fall term. She currently is also a guest lecturer at International Tax Center Leiden, lecturing some Tax Treaties courses for ITC Leiden South-East Asia Program in International Tax Law at Jakarta, Indonesia and ITC Leiden Summer Course at Shanghai, China. She is awarded with fully-funded scholarships by China Scholarship Council for her Adv. LL.M and her PhD research at Leiden.

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