The Supreme Administrative Court cancelled a rather disputable decision of the Regional Court in České Budějovice issued at the beginning of last year on the grounds of its unreviewability. It also stated several significant facts in its ruling (ruling 2 Afs 103/2018 – 46) regarding the approach to assessing the criterion of an agent’s dependence, ie, the role of commentary in interpreting the Double Tax Treaty.
The case dealt with quite a complicated situation. The tax administrator deduced that the Czech company ES (which considered itself to be a German tax resident based on its place of actual management in Germany and taxed the income achieved from the business activity in Germany in compliance with the provisions of the Double Tax Treaty concluded between Germany and the Czech Republic) generated the income from sources in the Czech Republic through a permanent establishment as a dependent agent. The permanent establishment in the Czech Republic was to be established by means of a contractual relationship with an unrelated Czech company MSV that provided various administrative and client services to ES as this company did not have any employees in the Czech Republic.
The primary business activity of ES is the sale of work clothes and work aids and the tax administrator deduced that the activities performed by MSV for ES under a contract represented an independent and indispensable part of the business activities of ES, not just the activities of preparatory or auxiliary nature. Since MSV performed these services on a long-term basis and systematically (the contract was concluded for an indefinite period of time) and taking into account other circumstances (webpages in the Czech language, phone number and contact place in České Budějovice), the tax administrator concluded that in this situation it was possible to see the intent to approach an unlimited number of clients with the aim of realising business deals there, ie, also profits. The Regional Court in its ruling 50 Af 33/2017 – 32 confirmed the conclusion of the tax administrator.
What about the Supreme Administrative Court
First, the Supreme Administrative Court stated that the decision of the Regional Court is unreviewable as it had stated inaccurate or misleading data in the substantiation thereof that did not correspond to the contents of the tax administrator’s file and findings. Subsequently, it gave a statement on the merit of the case – ie, on the construction of the Double Tax Treaty (DTT), and especially the relevant article dealing with the creation of permanent establishment through a dependent agent.
Primarily, it gave a statement that a model treaty (and the commentary thereon) can be used as additional means to interpret the DTT, whereby it is necessary that the interpretation corresponds to the text of the concluded treaty (through which it de-facto confirms the so-called historical approach to the interpretation of the commentary and model treaty): “The additional means of interpretation can undoubtedly also include the so-called OECD model treaty as a sample document based on which the relevant international convention was concluded between two particular countries (contracting parties). In this sense the model treaty can be, with a certain amount of simplification, compared to the explanatory memorandum of a bill of act. It is not a source of law but interpretation guidance on a retrospective deduction of the intent of contracting parties. As a matter of logic, such a purpose can be performed by the model treaty (and the commentary thereon) only provided the text of the model treaty in its decisive sections fundamentally corresponds to the text of a concluded and ratified international treaty.“
Subsequently, the Supreme Administrative Court engaged in assessing the creation of the permanent establishment. It stated that the provisions of Article 5(4) of the DTT expressly determined as one of the conditions of the qualification of a person as a dependent agent that such a person was not simultaneously an “independent agent” in which the court refers to the determination of independent agent pursuant to related Article 5 of the DTT. According to the Supreme Administrative Court, the tax administrator did not deal at all with the commentary on this article in its decision, it only stated that the “activity of MSV represented an independent and indispensable part of the business activities of the tax person that could not be considered the activities of preparatory or auxiliary nature or the activities of an independent service provider.”
Referring to the interpretation of the commentary, the Supreme Administrative Court states that a certain person can be considered an independent agent, if it is independent of a company both legally and economically and, simultaneously, in acting on behalf the company, it acts in the normal course of its business.
Specifically, the SAC states the most relevant criteria to assess the dependence:
- Legal and economic independence of the agent depends on the scope of the obligations the agent has in relation to the company. If its activity is subject to detailed instructions and broad supervision by the company, such a person cannot be considered independent of the relevant company.
- Another criterion is whether a business risk is borne by the agent or the company itself. The independent agent will not generally be subject to substantial control as regards the manner in which it performed work for the company. Also, it will not be subject to detailed instructions by its superior regarding the manner in which it is to perform the work.
- The fact that a principal relies on special skills and knowledge of the agent is a sign of independence.
- Another factor that must be taken into account in assessing the question of independence is the number of principals to be represented by the agent. The independence is less probable, if the activities of the agent are, in the course of their performance or on a long-time basis, performed exclusively or almost exclusively for one company. To assess the question of whether the activities of the agent represent an autonomous business of this agent as part of which it bears risks and is rewarded for applying his business skills, it is necessary to take into account all facts and circumstances. If the agent acts as part of its normal business activity for multiple principals and none of them are a main principal from the perspective of the activities performed by the agent, the legal dependence can exist, if the principals act in agreement in controlling the activity of the agent performed on their behalf. Persons cannot be considered the persons acting as part of their common activity, if, instead of the relevant company, they perform the activities that, from an economic point of view, fall within the sphere of the company’s activity rather than in the area of their own business activity.
Based on the above-mentioned the SAC concluded that the permanent establishment of ES had not been created in the Czech Republic through a dependent agent and thus the Czech Republic is not entitled to the taxation of (a part of) profits of this company in compliance with Article 7 of the relevant DTT.
The article is part of dReport – May 2019, Tax news; Grants and investment Incentives.