Market-led business communities go
jurisdiction shopping so that they could sell their products in
countries where the demand for their products existed or could be
created. Domestic tax is an obligation while foreign tax is a cost.
Consequently, to balance their need to penetrate more markets but at the same time to have healthy bottomlines, corporate structuring was evolved.
Judicial authorities, however, have caught up in this race and are analyzing microscopically the ingeniously designed structures aimed to deprive the source countries of their fair share of revenue.
A look at recent rulings gives the impression that judges are willing to reinvent the wheel and challenge long-standing interpretations/commentaries which thus far had been taken for granted to be the correct law.
This article seeks to analyze the
recent rulings by the Italian Corte Suprema di Cassazione (court) in
the case of Ministry of Finance vs Philip Morris dated March 7,
‘02.
The court gave two rulings, one in
relation to direct taxes and the other in relation to VAT. In these
rulings, the court has laid down five principles for determining PE.
The rulings have the effect of
widening the PE concept, especially in relation to multinational
group structures, which may have within its fold a hidden PE entity.
Philip Morris GmbH (the PMG Co) had
entered into distribution agreements with the Italian state monopoly
(AAMS) for the sale of cigarettes in Italy. Under the agreements,
the PMG Co could appoint a representative in Italy to visit
warehouses and sales outlets and accordingly it appointed Intertaba
Spa (IS Co).
PMG Co was assessed to direct taxes as
well as VAT on the contention that IS Co constituted a PE of the PMG
Co due to its role in the negotiations between PMG Co and AAMS.
PMG Co won before the second level
court and the case then came up as appeal. The court laid down five
principles for determining whether a PE exists and remanded the case
back to the lower court to compute the tax liability by applying
these principles.
In its observations, the court
stressed on the aspect that the IS Co transactions with PMG Co and
other group companies, had been so structured as to avoid IS Co
being regarded as a PE in Italy.
The court referred to opinions of
lawyers and internal documents relating way back to the ‘70s
regarding the possible exposure to PE.
The court accepted the lower court’s
view that these documents amounted to confession of the intention to
conceal the existence of a PE and contained the possible solutions
in order to protect the group companies from tax exposure in Italy.
Further, the documents also revealed
that the activities of IS Co were directed and directly co-ordinated
by the top management of the group for the purpose of attaining the
uniform group objective.
A company could constitute a multiple
PE of foreign group companies as supervision and control of the
proper performance of a contract cannot per se be categorized as
merely an auxiliary activity.
Participation of representatives even
in a single phase of business would constitute authority to conclude
contracts in the name of the foreign entity; management activities
carried out on behalf of a foreign entity, even though restricted to
a certain area of the group business would cause such entity to be
regarded as a PE; substance over form approach must be adopted for
determining existence of PE.Determination of existence of a PE in
the source country is a fact driven exercise and thus no
strait-jacket formula can be evolved for such determination.
In the Philip Morris ruling, the court
by widening the gamut for such determination has made an attempt to
reconcile old definitions to new commercial realities.
However, these principles do not
simplify the matter, in fact they could potentially lead to more
confusion in the fact-finding process.
Fixed place of business or
dependent-agent relationship are the prerequisites for the domestic
entity to be regarded as a PE of the foreign parent.
Thus, rendering of management services
or participating in negotiations cannot, on a stand-alone basis, be
the grounds for holding the domestic entity a PE of its foreign
parent.
No doubt laws need to keep pace with
commercial developments, however arbitrary, and change before the
appropriate time could do more harm than good.