Formula One – A formula that went wrong!
In this
post, I do not intend to go into the factual matrix of the case, coming as it
does, more than 9 months after the decision. The post is prompted by the earlier
post on AAR in Production Resource Group – a ruling that followed the Supreme
Court in FOWC.
Here, you will find judgements, opinions and commentaries referred by
the Supreme Court in concluding that even a 3 day racing ( preceded by a week
and succeeded by 2 weeks) can constitute a PE. Comments and Analysis are at the end!
Philip
Baker
The [PE] concept marks the
dividing line for businesses between merely trading with a country and trading
in that country; if an enterprise has a PE, its presence in a country is
sufficiently substantial that it is trading in the country.
In the first type of PE,
i.e. associated permanent establishments, primary requirement is that there
must be a fixed place of business through which the business of an enterprise
is wholly or partly carried on. It entails two requirements which need to be
fulfilled: (a) there must be a business of an enterprise of a Contracting State;
and (b) PE must be a fixed place of business, i.e. a place which is at the
disposal of the enterprise. It is universally accepted that for ascertaining
whether there is a fixed place or not, PE must have three characteristics:
stability, productivity and dependence. Further, fixed place of business
connotes existence of a physical location which is at the disposal of the
enterprise through which the business is carried on.
Some of the examples of
fixed place of business given by Baker are the following:
The place of business must
be fixed and permanent. Thus, a shed which had been rented for thirteen years
for storing and preparing hides was held to constitute a PE. Similarly, a
writer's study has been held to constitute a PE. A stand at a trade fair,
occupied regularly for three weeks a year, through which the enterprise
obtained contracts for a significant part of its annual sales, has also been
held to constitute a PE. A temporary restaurant operated in a mirror tent at a
Dutch flower show for a period of seven months was held to constitute a PE. An
office, on the other hand, possession of a mailing address in a state - without
an office, telephone listing or bank account - has been held not to constitute
a PE. The mere supply of skilled labour to work in a country did not give rise
to a PE of the company supplying the labour. A drilling rig which, although
anchored while in operation, was moved to a new site every few months, has been
held not to constitute a PE. Similarly, a remotely operated vessel which was used
to inspect and repair submarine pipelines was held not to constitute a PE
because a moving vessel is not a fixed place of business.
The principal test, in
order to ascertain as to whether an establishment has a fixed place of business
or not, is that such physically located premises have to be ‘at the disposal’
of the enterprise. For this purpose, it is not necessary that the premises are
owned or even rented by the enterprise. It will be sufficient if the premises
are put at the disposal of the enterprise. However, merely giving access to
such a place to the enterprise for the purposes of the project would not
suffice. The place would be treated as 'at the disposal' of the enterprise when
the enterprise has right to use the said place and has control thereupon.
Klaus Vogel
Interpreting the OECD
Article 5 pertaining to PE, Klaus Vogel has remarked that insofar as the term
'business' is concerned, it is broad, vague and of little relevance for the PE
definition. According to him, the crucial element is the term 'place'.
Importance of the term 'place' is explained by him in the following manner:
"In conjunction with
the attribute 'fixed', the requirement of a place reflects the strong link
between the land and the taxing powers of the State. This territorial link
serves as the basis not only for the distributive rules which are tied to the
existence of PE but also for a considerable number of other distributive rules
and, above all, for the assignment of a person to either Contracting State on
the basis of residence (Article 1, read in conjunction with Article 4 OECD and
UN MC)."
Vogel defines 'place' as
under:
"A place is a certain
amount of space within the soil or on the soil. This understanding of place as
a three-dimensional zone rather than a single point on the earth can be derived
from the French Version ('installation fixe') as well as the term
'establishment'. As a rule, this zone is based on a certain area in, on, or
above the surface of the earth. Rooms or technical equipment above the soil may
quality as a PE only if they are fixed on the soil. This requirement, however,
stems from the term 'fixed' rather than the term 'place', given that a place
(or space) does not necessarily consist of a piece of land. On the contrary,
the term 'establishment' makes clear that it is not the soil as such which is
the PE but that the PE is constituted by a tangible facility as distinct from
the soil. This is particularly evident from the French version of Article 5(1)
OECD MC which uses the term 'installation' instead of 'place'.
The term 'place' is used to
define the term 'establishment'. Therefore, 'place' includes all tangible assets
used for carrying on the business, but one such tangible asset can be
sufficient. The characterization of such assets under private law as real
property rather than personal property (in common law countries) or immovable
rather than movable property (in civil law countries) is not authoritative. It
is rather the context (including, above all, the terms 'fixed'/'fixe'), as well
as the object and purpose of Article 5 OECD and UN MC itself, in the light of
which the term 'place' needs to be interpreted. This approach, which follows
from the general rules on treaty interpretation, gives a certain leeway for
including movable property in the understanding of 'place' and, therefore, the
assume a PE once such property has been 'fixed' to the soil.
For example, a work bench
in a caravan, restaurants on permanently anchored river boats, steady oil rigs,
or a transformator or generator on board a former railway wagon qualify as
places (and may also be 'fixed').
In contrast, purely
intangible property cannot qualify in any case. In particular, rights such a
participations in a corporation, claims, bundles of claims (like bank
accounts), any other type of intangible property (patents, software, trademarks
etc.) or intangible economic assets (a regular clientele or the goodwill of an
enterprise) do not in themselves constitute a PE. They can only form part of PE
constituted otherwise. Likewise, an internet website (being a combination of
software and other electronic data) does not constitute tangible property and,
therefore, does not constitute a PE.
Neither does the mere
incorporation of a company in a Contracting State in itself constitute a PE of
the company in that State. Where a company has its seat, according to its
by-laws and/or registration, in State A while the POEM is situated in State B,
this company will usually be liable to tax on the basis of its worldwide income
in both Contracting States under their respective domestic tax law. Under the
A-B treaty, however, the company will be regarded as a resident of State B only
(Article 4(3) OECD and UN MC). In the absence of both actual facilities and a
dependent agent in State A, income of this company will be taxable only in
State B under the 1st sentence of Article 7(1) OECD and UN MC.
There is no minimum size of
the piece of land. Where the qualifying business activities consist (in full or
in part) of human activities by the taxpayer, his employees or representatives,
the mere space needed for the physical presence of these individuals is not
sufficient (if it were sufficient, Article 5(5) OECD MC and Article 5(5)(a) UN
MC and the notion of agent PEs were superfluous). This can be illustrated by the
example of a salesman who regularly visits a major customer to take orders, and
conducts meetings in the purchasing director's office. The OECD MC Comm. has
convincingly denied the existence of a PE, based on the implicit understanding
that the relevant geographical unit is not just the chair where the salesman
sits, but the entire office of the customer, and the office is not at the
disposal of the enterprise for which the salesman is working.
Vogel has also emphasised
that the place of business qualifies only if the place is 'at the disposal' of
the enterprise. According to him, the enterprise will not be able to use the
place of business as an instrument for carrying on its business unless it
controls the place of business to a considerable extent. He hastens to add that
there are no absolute standards for the modalities and intensity of control.
Rather, the standards depend on the type of business activity at issue.
According to him, 'disposal' is the power (or a certain fraction thereof) to
use the place of business directly.
Some of the instances given
by Vogel in this behalf, of relative standards of control, are as under:
The degree of control
depends on the type of business activity that the taxpayer carries on. It is
therefore not necessary that the taxpayer is able to exclude others from
entering or using the POB.
The painter example in the
OECD MC Comm. (no. 4.5 OECD MC Comm. on Article 5) (however questionable it
might be with regard to the functional integration test) suggests that the type
and extent of control need not exceed the level of what is required for the
specific type of activity which is determined by the concrete business.
By contrast, in the case of
a self-employed engineer who had free access to his customer's premises to
perform the services required by his contract, the Canadian Federal Court of
Appeal ruled that the engineer had no control because he had access only during
the customer's regular office hours and was not entitled to carry on businesses
of his own on the premises.
Similarly, a Special Bench
of Delhi's Income Tax Appellate Tribunal denied the existence of a PE in the
case of Ericsson. The Tribunal held that it was not sufficient that Ericsson's
employees had access to the premises of Indian mobile phone providers to
deliver the hardware, software and know-how required for operating a network.
By contrast, in the case of a competing enterprise, the Bench did assume an
Indian PE because the employees of that enterprise (unlike Ericsson's) had
exercised other businesses of their employer.
The OECD MC shows a
paramount tendency (though no strict rule) that PEs should be treated like
subsidiaries (cf. Article 24(3) OECD and UN MC), and that facilities of a
subsidiary would rarely been unusable outside the office hours of one of its
customers (i.e. a third person), the view of the two courts is still more
convincing.
Along these lines, a POB
will usually exist only where the taxpayer is free to use the POB:
- at any time of his own
choice;
- for work relating to more than one customer; and
- for his internal
administrative and bureaucratic work.
In all, the taxpayer will
usually be regarded as controlling the POB only where he can employ it at his
discretion. This does not imply that the standards of the control test should
not be flexible and adaptive. Generally, the less invasive the activities are,
and the more they allow a parallel use of the same POB by other persons, the
lower are the requirements under the control test. There are, however, a number
of traditional PEs which by their nature require an exclusive use of the POB by
only one taxpayer and/or his personnel. A small workshop (cf. Article 5(2)(e)
OECD and UN MC) of 10 or 12 square meters can hardly be used by more than one
person. The same holds true for a room where the taxpayer runs a noisy machine.
OECD Commentary:
OECD commentary on Model
Tax Convention mentions that a general definition of the term 'PE' brings out
its essential characteristics, i.e. a distinct "situs", a "fixed
place of business". This definition, therefore, contains the following
conditions:
- the existence of a
"place of business", i.e. a facility such as premises or, in certain
instances, machinery or equipment.
- this place of business
must be "fixed", i.e. it must be established at a distinct place with
a certain degree of permanence;
- the carrying on of the
business of the enterprise through this fixed place of business. This means
usually that persons who, in one way or another, are dependent on the
enterprise (personnel) conduct the business of the enterprise in the State in
which the fixed place is situated.
The term "place of
business" is explained as covering any premises, facilities or
installations used for carrying on the business of the enterprise whether or
not they are used exclusively for that purpose. It is clarified that a place of
business may also exist where no premises are available or required for
carrying on the business of the enterprise and it simply has a certain amount
of space at its disposal. Further, it is immaterial whether the premises,
facilities or installations are owned or rented by or are otherwise at the
disposal of the enterprise. A certain amount of space at the disposal of the
enterprise which is used for business activities is sufficient to constitute a
place of business. No formal legal right to use that place is required. Thus,
where an enterprise illegally occupies a certain location where it carries on
its business, that would also constitute a PE.
OECD examples where
premises are treated at the disposal of the enterprise and, therefore,
constitute PE are: a place of business
may thus be constituted by a pitch in a market place, or by a certain
permanently used area in a customs depot (e.g. for the storage of dutiable
goods). Again the place of business may be situated in the business facilities
of another enterprise. This may be the case for instance where the foreign
enterprise has at its constant disposal certain premises or a part thereof
owned by the other enterprise. At the same time, it is also clarified that the
mere presence of an enterprise at a particular location does not necessarily
mean that the location is at the disposal of that enterprise.
The OECD commentary gives
as many as four examples where location will not be treated at the disposal of
the enterprise. These are:
(a) The first example is
that of a salesman who regularly visits a major customer to take orders and
meets the purchasing director in his office to do so. In that case, the customer's
premises are not at the disposal of the enterprise for which the salesman is
working and therefore do not constitute a fixed place of business through which
the business of that enterprise is carried on (depending on the circumstances,
however, paragraph 5 could apply to deem a permanent establishment to exist). b)
Second example is that of an employee of a company who, for a long period of time,
is allowed to use an office in the headquarters of another company (e.g. a
newly acquired subsidiary) in order to ensure that the latter company complies
with its obligations under contracts concluded with the former company. In that
case, the employee is carrying on activities related to the business of the
former company and the office that is at his disposal at the headquarters of
the other company will constitute a permanent establishment of his employer,
provided that the office is at his disposal for a sufficiently long period of
time so as to constitute a "fixed place of business" (see paragraphs
6 to 6.3) and that the activities that are performed there go beyond the
activities referred to in paragraph 4 of the Article. (c) The third example is that
of a road transportation enterprise which would use a delivery dock at a
customer's warehouse every day for a number of years for the purpose of
delivering goods purchased by that customer. In that case, the presence of the
road transportation enterprise at the delivery dock would be so limited that
that enterprise could not consider that place as being at its disposal so as to
constitute a permanent establishment of that enterprise. (d) Fourth example is
that of a painter, who, for two years, spends three days a week in the large
office building of its main client. In that case, the presence of the painter
in that office building where he is performing the most important functions of
his business (i.e. painting) constitute a permanent establishment of that
painter.
It also states that the
words 'through which' must be given a wide meaning so as to apply to any
situation where business activities are carried on at a particular location
which is at the disposal of the enterprise for that purpose. For this reason,
an enterprise engaged in paving a road will be considered to be carrying on its
business 'through' the location where this activity takes place.
"The words 'permanent
establishment' postulate the existence of a substantial element of an enduring
or permanent nature of a foreign enterprise in another country which can be
attributed to a fixed place of business in that country. It should be of such a
nature that it would amount to a virtual projection of the foreign enterprise
of one country into the soil of another country."
Universal Furniture Ind. AB
v. Government of Norway Case No. 99-00421, dated 19-12- 1999 :
A Swedish company sold
furniture abroad that was assembled in Sweden. It hired an individual tax
resident of Norway to look after its sales in Norway, including sales to a
Swedish company, which used to compensate him for use of a phone and other
facilities. Later, the company discontinued such payments and increased his
salary. The Norwegian tax authorities said that the Swedish company had its
place of business in Norway. The Norwegian court agreed, holding that the salesman's
house amounted to a place of business: it was sufficient that the Swedish
Company had a place at its disposal, i.e the Norwegian individual's home, which
could be regarded as 'fixed'.
Joseph Fowler v. Her Majesty
the Queen 1990 (2) CTC 235:
The issue was whether a
United States tax resident individual who used to visit and sell his wares in a
camper trailer, in fairs, for a number of years had a fixed place of business
in Canada. The fairs used to be once a year, approximately for three weeks each.
The court observed that the
nature of the individual's business was such that he held sales in similar
fares, for duration of two or three weeks, in two other locales in the United
States. The court held that conceptually, the place was one of business,
notwithstanding the short duration, because it amounted to a place of
management or a branch having regard to peculiarities of the business.
Comments and Analysis
3 days too
short for a PE? Though the decision may
have upset those who thought a 3-day affair could never have created a PE, the
Delhi High Court decision overruling the AAR and the subsequent judgement of
the Supreme Court in FOWC shows how one needs to contextualise the duration to
the nature and requirement of business in each case. Even complicated and carefully laid out arrangements
can fail when one goes to the root of the matter. In coming to its conclusion, the Apex Court negatived the arguments that FOWC never had any place of business at its disposal, did not carry on any business, never had exclusive control over the Circuit and in any case, possession of a place for 3 days could not constitute a PE.
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