Tax Treaty Series

ITQ T-

081

March 26, 2021

Question

XCo, a company resident in X, manufactures and sells goods.

YCo, a company resident in Y, is a 100% subsidiary of XCo. YCo provides marketing services to XCo. Those services include: identifying potential customers for XCo, showing the potential customers XCo's standard contract and price list, convincing potential customers to make orders for XCo's goods, and receiving orders from customers. The orders are not accepted by YCo (which has been given no authority by XCo to accept orders) – instead, YCo sends the orders to XCo, for XCo's approval (or otherwise). On almost all occasions, XCo accepts the order.

YCo plays no role in regard to the delivery of goods to the customers or in regard to billings and collections.

XCo pays a fee to YCo equal to YCo's costs plus 5%.

The X/Y treaty is identical to the 2014 OECD model treaty.

Does XCo have a PE in Y under the X/Y treaty? If so, how would its taxable profit in Y be determined?

Answer

(1) PE existence:

The key issue is whether YCo exercises an authority to conclude contracts in the name of XCo (Art. 5(5)). According to the OECD Comm., "in the name of" means "binding on".

XCo has not given authority to YCo to accept customer orders.

Nevertheless, if YCo holds itself out as having such authority, it is possible that a Y court would conclude that, under the relevant contractual law, YCo has ostensible (apparent) authority to bind XCo. However, the facts do not expressly indicate that this is the case.

The French Supreme Court in the Valueclick case (2020) effectively held that paras. 32.1 & 33 in the 2014 OECD Comm. support the view that, if the agent plays the principal role leading to the conclusion of contracts that are routinely concluded by the principal, then Art. 5(5) in the 2014 or earlier OECD model treaties will be satisfied – despite the fact that those words were added only in the 2017 model.

The facts here are similar to those in Valueclick. Thus, there is a risk that a Y court would reach a similar conclusion. Nevertheless, IMHO, those paragraphs in the 2014 OECD Comm. do not support the decision in Valueclick – and, thus, in the absence of actual authority or ostensible authority, Art. 5(5) should not apply.

(2) Profit attributable to PE:

Regardless of whether there is a PE, YCo's fee must be reviewed under Art. 9. As YCo appears to exercise some risk control functions, it is possible that an increase should be made to YCo's fee.

If a PE exists, the profit attributable to the PE must be determined in accordance with the Authorised OECD Approach (AOA), recognising that the PE and YCo are 2 separate taxpayers in Y. If YCo does exercise some risk control functions, it is likely that those functions are "significant people functions" for Art. 7 purposes. However, the OECD's 2018 report on Art. 7 warns against attributing the same functions to both the agent and the agency PE. If YCo's fee is increased under Art. 9, it is therefore likely that the profit attributable to the PE would be low or nil.

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