INSIGHT: Taxation of the Digital Economy in France—Where are We? Part 1

The digitalization of the economy raises tax challenges—it is to be hoped that the OECD will be able to obtain global consensus on this issue.

One of the most relevant measures for a highly digitalized business includes the change of the permanent establishment (“PE”) definition. The objective of this amendment is to provide existing tax treaties with sufficiently broad definitions to embrace the digital economy, which is currently not the case as recently illustrated by two decisions of the French courts.

PE and Digital Economy?

The attribution of taxing rights for companies within an international environment is based on the concept of PE. Since the recognition of a PE depends on the physical presence of the company in a given country, the current definition does not take into consideration digital factors. For this reason, abusive tax planning have emerged in practice that the tax authorities have tried to prevent.

The implementation of such abusive tax schemes does not lead to the characterization of a PE and may involve the fragmentation of preparatory activities between related companies or the splitting-up of contracts.

With respect to this latter scheme, French tax authorities have been accustomed to adjust foreign companies entering into contracts with French customers and being assisted locally by French companies providing them with marketing and support services in exchange for routine fees.

These foreign companies are considered by the tax authorities as having a PE in France through these service providers qualified as dependent agents which would entail the allocation of the profits generated from the French activity in France rather than overseas.

In this context, two decisions issued by the Paris Administrative Court on the Google case and the Paris Administrative Court of Appeal on the ValueClick case illustrate the current approach adopted by the tax authorities and thus serve as a reminder of the conditions that must be met to characterize a PE.

Google Case

In the Google case,Google Ireland provides an advertising service as part of its “AdWords” program to its customers which include French ones. As Google Ireland does not have any physical presence in France, Google Ireland has entered into a Marketing and Services Agreement (“MSA”) with Google France pursuant to which the latter will provide marketing services to Google Ireland to support its sales to French customers.

Google France is then acting as a service provider for Google Ireland and receives a compensation equals to its costs + 8 percent. However, the MSA provides that Google France has no authority to bind Google Ireland or to sign any contract or agreement on behalf of Google Ireland. In other words, Google France was not formally involved in the sales of Google Ireland.

The French tax authority was of the opinion that Google Ireland had a PE in France through Google France leading to a tax reassessment of 1.1 billion euros for fiscal years 2005 to 2010. Google challenged this tax audit which led to a landmark decision rendered by the Administrative Court of Paris on July 12, 2017.

The existence of a PE may be characterized if a company has a fixed place of business in another country or a dependent agent. In order to demonstrate the existence of a dependent agent, which was the key-point in the Google case, two criteria must be met:

• the agent’s dependence on the company; and

• the agent’s power to conclude contract on its behalf.

An Easily Recognized Criterion

The court first considered that Google France was a dependent agent of Google Ireland both from a legal point of view, given that these two entities are ultimately owned by Google Inc. (U.S. company), and from an economic point of view, as Google France provides services exclusively to Google Ireland and does not bear any financial risk thanks to its guaranteed remuneration (cost plus).

A More Complex Criterion

The tax authorities argued that, although the terms of the MSA explicitly deny Google France any authority to engage Google Ireland, Google France’s employees would have been “in effect” vested with the power to enter into contracts on Google Ireland’s behalf, claiming that advertising contracts were “negotiated” and then “substantially concluded” by them.

In support of its position, the French tax authorities raised elements showing that Google France were deeply involved in the sales process such as internal documents explaining the functions of Google France’s employees (e.g. developing the turnover or “the recruitment of new clients”) or sales functions in Google France’s job offers.

The court held that, although these elements might tend to make the tasks of certain employees of Google France appear to go beyond the strict framework of the missions assigned to Google France under the MSA, these elements did not establish that these employees had the power to act on Google Ireland’s behalf.

The court’s analysis relied on the advertising contracts signed by Google Ireland with the final customers and emphasized the fact that:

• they were expressly concluded between the customer and Google Ireland;

• there was no evidence that the legal terms of these contracts had not been established by Google Ireland; and

• advertisements could not be placed online until Google Ireland’s final validation.

The court then analyzed the situation, in light of the legal agreements only, and rejected the economic approach of the French tax authorities. At first glance, this decision seems in line with the position of the French Supreme Court.

In this decision, the court decided that a commissionaire cannot bind the principal to its co-contracting parties based on a strict legal analysis. Accordingly, the commissionaire could not be viewed as a PE of the principal. However, the court indicated that the situation would be different in the event that the agreement or other elements show that, despite the qualification of the contract, the principal is bound by the agreements signed by the commissionaire with third parties.

In the Google case, Google France’s employees were not legally empowered to act on behalf of Google Ireland and in any event could not bind Google Ireland who was the ultimate decision maker with respect to the signature of the agreements. This then precludes the existence of a PE.

It is interesting to note that a similar case was brought before the Administrative Court of Appeal of Paris a few months after which confirmed the reasoning of the Google case.

ValueClick International Case

ValueClick International has implemented a similar structure to the one already analyzed in the Google case.

ValueClick International has entered into a Services Agreement with ValueClick France under which the latter provides marketing, management and back-office support services and administrative services (accounting, IT and cash management) for the French market. This intra-group service contract notably specified that it could not have the effect of authorizing ValueClick France to undertake or contract on behalf of ValueClick International.

The tax authorities considered that ValueClick International had in France both a fixed place of business and a dependent agent, thus characterizing the existence of a PE in France.

ValueClick International’s Fixed Place of Business

According to the analysis carried out by the tax authorities, the Paris Administrative Court considered that “the employees of ValueClick France acted on behalf of the applicant company in prospecting and commercial negotiations with clients, drawing up contracts, performing services and collecting them.”

The court concluded that these employees were not acting solely within the framework defined by the intra-group services agreement referred to above. It therefore concluded that a fixed place of business of ValueClick International existed in France in the premises of ValueClick France.

The Administrative Court of Appeal did not follow this point and considered that the above missions did not exceed those provided for by the intra-group service contract, given the general nature of the missions it described. In this particular case, the activity of marketing and support services provider exercised by ValueClick France was not likely to correspond to the activity of a PE, distinct from its own activity. It therefore concluded that ValueClick International did not have a fixed place of business within the meaning of the French–Ireland tax treaty in France.

ValueClick International’s Dependent Agent

The French tax authorities also considered that the employees had, in fact, the power to conclude contracts on behalf of ValueClick International.

In particular, it considered that the foreign company’s validation of contracts was purely automatic and that French employees were involved in negotiating, drawing up contracts and setting up and monitoring advertising campaigns.

However, the court held that these elements were not such as to establish that the employees of ValueClick France had been vested with the power to act in the name and on behalf of ValueClick International. In this respect, two important elements undoubtedly influenced the court:

• the setting of general conditions of sales and prices by ValueClick International; and

• the provision of services which could not begin before the validation of the contracts by ValueClick International.

Indeed, beyond the signature of the contract itself, it is important to stress that no service could begin to be rendered without validation and signature of the contracts by ValueClick International. This element highlights that only the intervention of ValueClick International allows the formation of the contract. Thus, the factual reality corresponds to the contractual reality agreed between the parties. Consequently, ValueClick France could not be regarded as having had the power to bind ValueClick International.

Rejecting the tax administration’s analysis, the court took a legal approach to the power to enter into commitments, in accordance with the provisions of the France–Ireland tax treaty.

Therefore, structure commonly put in place by digital companies should not trigger the existence of a PE in France. In any event, in case a PE would be characterized, this would not necessarily mean that the profits generated by these agreements will be allocated to the French PE as highlighted by the OECD in the latest guidance on attribution of profits to a PE published in March 2018.

Indeed, profits attributable to a PE are those that the PE would have derived if it were a separate and independent enterprise engaged in the same or similar activities under the same or similar conditions.

With respect to the two cases mentioned above, a third party would then have to acquire advertising spaces from the head office (the Irish entity) in order to resell it to the French final customers. The amount deemed to be paid by the PE to the head office would be treated as deductible expense. The net amount of profits attributable to the PE could then be positive but also negative depending notably on the turnover generated by the PE from the advertising sales.

Planning Points

Operators should carefully review the way they operate in France in light of the recent developments by the French courts. This would particularly be the case for a MNC operating in France through a local service provider in charge of promoting the group’s services in France.

Part 2 will consider the change in definition of PE and the MLI.

Bertrand Hermant is Counsel at Taylor Wessing, Paris

The author would like to thank Antoine Bazart for his assistance in the drafting of this article.