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WHAT KIND OF AGENT ARE YOU?HISTORY OF THE PERMANENT ESTABLISHMENT CONCEPT AND PROPOSED SOLUTIONS TO BETTER CLARIFY THE AGENCY THEORYTony K. Nguyen

I. INTRODUCTION AND HISTORY OF THE PERMENANT ESTABLISHMENT CONCEPT.

Countries entering into bilateral tax treaties often worry about the issue of double taxation. This issue arises when individuals and entities of a country must pay taxes on profits generated at home and abroad, even though they may have weak or sporadic economic presence in the foreign country. To avoid double taxation, countries often negotiate bilateral tax treaties to require that their individuals and entities have a permanent establishment (PE) in the hosting country before having to pay taxes on profits generated within that country.[footnoteRef:1] [1: Leonardo F.M. Castro, Problems Involving Permanent Establishments: Overview of Relevant Issues in Todays International Economy, 2 Global Bus. L. Rev. 125, 128-129 (2012).]

A. The PE concept was developed to prevent double-taxation and facilitate cross-border trade between countries

The early version of the PE concept originated in eastern Prussia in the mid-19th century as a method of preventing double taxation among the Prussian municipalities.[footnoteRef:2] While the concept was not codified in statute until decades later, the early judicial interpretations laid the framework for the core elements of the PE concept.[footnoteRef:3] According to the Prussian courts, for a PE to exist, an enterprise must have a fixed physical location in the foreign jurisdiction and must express intention to perform business activity at this place.[footnoteRef:4] Together, these two criteria formed the objectives test that a tax court would apply before subjecting a non-local enterprises business activities to the taxing jurisdiction.[footnoteRef:5] It was not until the latter 19th and early 20th century, with the passage of the Prussian Income Tax Act of 1891 (the Einkommenseuergesetz) and the German Double Taxation Act of 1909, respectively, that the concept of the PE was codified for use in the German and Prussian territories.[footnoteRef:6] [2: ARVID A. SKAAR, PERMANENT ESTABLISHMENT: EROSION OF A TAX TREATY PRINCIPLE 72 (1991).] [3: Id. at 73.] [4: Id.] [5: Id.] [6: Id. at 74]

But by the turn of the century, with growing economic interactions among countries and the need to facilitate cross-border trade, European nations began to incorporate the PE concept in its international trade treaties. The first of such international tax treaty was between Prussia[footnoteRef:7] and Austria-Hungary, signed on June 21, 1899.[footnoteRef:8] Pursuant to this treaty, business profits earned in the other country through a PE were to be taxed there. Moreover, the treaty kept the PE definition similar to how the Prussian courts originally interpreted it (that is, a requirement that there be a fixed place of business) and provided a list of examples of fixed places that would constitute a PE.[footnoteRef:9] In the following years up until the outbreak of World War I, other Central European nations concluded international tax treaties with similar PE definitions, for example: Austria-Hungary and Liechtenstein (1901), Austria-Hungary and Saxony (1903), Austria-Hungary and Bavaria (1903), and Austria-Hungary and Wrrtemberg (1905).[footnoteRef:10] These first tax treaties, while keeping loyal to the fixed place of business test proffered by the Prussian courts, also reflected the realization that an enterprise could be taxed not only on its physical connection to a jurisdiction, but also its personal connection.[footnoteRef:11] European nations therefore expanded the concept of PE beyond the fixed place of business test to allow taxation where the foreign enterprise also had an agent within the hosting country.[footnoteRef:12] But notably, these first tax treaties did not distinguish between a dependent and independent agent[footnoteRef:13], a concept that will be later discussed. [7: There is little surprise that the first international tax treaty incorporating the PE concept was signed with Prussia as one of the parties given that the concept originated in Prussia and was developed by the Prussian courts and legislature. ] [8: Id. at 75.] [9: Id. ] [10: Id. at 76.] [11: Id.] [12: Dale Pinto, E-Commerce and Source-Based Income Taxation, in 6 DOCTORAL SERIES OF IBFD 1, 7576 (2002)] [13: SKAAR, supra note 2, at 77.]

B. The End of WWI renewed interest in the PE concept and lead to the development of the 1927 Draft Convention

Despite Europes efforts to dampen the effects of double taxation through various ante-bellum tax treaties, the end of World War I in 1918 brought a renewed, if not invigorated, interest in the PE concept. Because of the high post-war tax rates and the utter destruction left on Europe and the rest of the world, double taxation now had an even more devastating effect on international trade and post-war reconstruction.[footnoteRef:14] Out of this concern, national governments and representatives of international businesses through the International Chamber of Commerce, founded in 1919, called upon the newly formed, supranational organization, the League of Nations, to take steps to end the evils of double taxation.[footnoteRef:15] In response, the League of Nations commissioned a group of tax specialists to come up with a legal mechanism against double taxation.[footnoteRef:16] The group issued a report to the League of Nations in 1925, which reaffirmed a more developed PE concept as the solution to double taxation.[footnoteRef:17] The League of Nations later codified the concept into its 1927 Draft Convention.[footnoteRef:18] [14: Id. at 77.] [15: Id. at 78; see also International Chamber of Commerce, Resolution No. 11 of the Inaugural Congress (1920).] [16: Arthur Cockfield, Reforming the Permanent Establishment Principle Through a Quantitative Economic Presence Test, 38 CAN. BUS. L.J. 400, 40002 (2003).] [17: The tax specialists came from a group called the Economists to the Financial Committee of the League of Nations. Their report is called The Report on Double Taxation, and may be found in League of Nations Doc. EFS 73 F 19 (1923) (Economists Report).] [18: Pinto, supra note 12, at 7576.]

Under this 1927 Draft Convention, the state where income was generated (i.e. the source state) may tax a foreign enterprise only if such enterprise had a PE there. Per the Draft Convention, a PE was defined as the following:The real centres of management, affiliated companies, branches, factories, agencies, warehouses, offices, depots, shall be regarded as permanent establishments. The fact that an undertaking has business dealings with a foreign country through a bona fide agent of independent status (broker, commission agent, etc.) shall not be held to mean that the undertaking in question has a permanent establishment in that country.[footnoteRef:19] [19: League of Nations, Double Taxation and Tax Evasion: Report of the Committee of Technical Experts on Double Taxation and Tax Evasion, Committee of Technical Experts art. 5(2) (1927). ]

A couple of items are worth noting about the PE definition in the 1927 Draft Convention. First, unlike the 1899 tax treaty between Prussia and Austria-Hungary, and the German Double Taxation Act of 1909, the Draft Convention does not discuss the fixed place of business test or present other, general definitions of a PE.[footnoteRef:20] Second, the inclusion of affiliated companies (which likely means parent companies or subsidiaries) as an example of PE was an unusual inclusion not generally seen before in previous, pre-War bilateral treaties, which generally only mentioned branches or branch establishments as examples of PE.[footnoteRef:21] Finally, and perhaps most notably, the Draft expressly exempts independent agents from the definition of PE, and therefore establishes an initial distinction between a PE-creating dependent agent and PE-exempted independent agent.[footnoteRef:22] [20: SKAAR, supra note 2, at 83.] [21: Id.] [22: Id. at 82 (noting that the exemption of independent agents from the definition of PE originated from domestic laws in the United Kingdom, which viewed agents established on the basis of commission as not an integral part of an enterprises business and therefore should not constitute a PE).]

Notwithstanding its clarifications and additions to the concept of PE, the 1927 Draft had little actual influence on the text of bilateral treaties.[footnoteRef:23] For example, the tax treaty between Hungary and Poland in 1928 seems to have been inspired by the original Prussian, fixed place of business notion of a PE, although some there are some traceable influence from the 1927 Draft.[footnoteRef:24] According to the treaty, a PE was defined as: [23: Id. at 83. ] [24: Id.]

[A]n establishment in which the undertaking carries on business . . . [where] . . . any permanent organization of an undertaking in which the business of the undertaking is wholly or partly carried. The following should more particularly be included under the term establishments: the seats of undertakings, the real centres of management, branches, subsidiary establishments, factories, workshops, offices where purchases or sales are effected, storehouses, depots and all industrial or commercial installations maintained for the purpose of carrying on the business of the undertaking by the owner of the undertaking himself, by his authorised representatives, or by other permanent agents. The term establishments should also be held to include all permanent representatives of the said undertakings.[footnoteRef:25] [25: DTA Hungary-Poland 1928, art. 3(3), translated by the Secretariat of the League of Nations, quoted from W.H. Diamond and D.B. Diamond, 1 INTERNATIONAL TAX TREATIES OF ALLNATIONS 1, 100 (Walter H. Diamond & Dorothy B. Diamond eds., 1975).]

Perhaps a notable difference between this treaty and the 1927 Draft is that that the former provides for a more extensive definition of a PE, which for example, allows taxation of subsidiary establishments, regardless of whether the subsidiary was authorized to conclude contracts on behalf of the parent enterprise.[footnoteRef:26] This expansive view of PE more closely conforms to the original Prussian notion of a PE, which appears more concerned with the justifying PE based on the source of the income rather than whether real centres of management, affiliated companies, branches, and the like exist to justify taxation.[footnoteRef:27] In fact, some developing countries like Chile had issues with the 1927 Draft definition and opted in favor of using the original Prussian notion of the PE. According to Chile, the PE concept, as defined by the Draft Convention, failed to expand the scope of PE to allow developing countries, which often emphasized the source of income, to justify taxation on foreign enterprises[footnoteRef:28]. This debate over the PE concept between developed and developing nations would continue to shape the definition of PE for the rest of the 20th century.[footnoteRef:29] [26: SKAAR, supra note 2, at 84.] [27: Id. ] [28: Id. ] [29: Indeed the debate between developing and developed nations over the fairness of the OECD Model Convention will eventually lead to the development of the U.N. Model Convention. See United Nations Department of International Economic and Social Affairs, United Nations Model Double Taxation Convention between Developed and Developing Countries (1980); see also Bart Kosters, The United Nations Model Tax Convention and Its Recent Developments, ASIA-PACIFIC TAX BULLETIN, Jan.Feb. 2004, at 45.]

C. The critiques of the 1927 Draft Convention lead to development of the Mexico and London Draft Treaty Agreements.

Given the critiques of its 1927 Draft definition and the refusal by some countries to use the Draft definition in their bilateral treaties, the League of Nations continued to work on broadening the scope of the PE concept.[footnoteRef:30] In the midst of the Second World War, the League hosted two regional conferences in 1940 and 1943 in Mexico City.[footnoteRef:31] The outcome of these conferences resulted to a new Draft Treaty, known as the Mexico Draft.[footnoteRef:32] Unlike the 1927 Draft, the Mexico Draft was more advantageous to developing countries with its premise that the primary taxing jurisdiction would be where the income was generated (i.e. the source state).[footnoteRef:33] In fact, according to the Mexico Draft, the starting point is that all business income would be taxable to the source state.[footnoteRef:34] The presence of a place of business and its permanence, while important, was not necessary for source-state taxation under the Mexico Draft.[footnoteRef:35] Rather, the main criterion for determining PE was the regularity and continuity of the business operations in the source state.[footnoteRef:36] [30: KEVIN HOLMES, INTERNATIONAL TAX POLICY AND DOUBLE TAX TREATIES: AN INTRODUCTION TO PRINCIPLES AND APPLICATION 57 (2007).] [31: Id.] [32: Id.] [33: Id.] [34: SKAAR, supra note 2, at 90; See also League of Nations, Mexico Model Tax Convention, Commentary and Text 2 (1943) (stating that [i]ncome from any industrial, commercial or agricultural business and from any other gainful activity shall be taxable only in the State where the business or activity is carried out.).] [35: SKAAR, supra note 2, at 90. ] [36: Id. See also League of Nations, Mexico Model Tax Convention, Commentary and Text 2 (1943) (stating that [i]f an enterprise or an individual in one of the contracting States extends its or his activities to the other State, through isolated or occasional transactions, without possessing in that State a permanent establishment, the income derived from such activities shall be taxable only in the first State.)]

While the Mexico Draft was important in shifting the focus towards source-state taxation to benefit developing countries, it did not go unchallenged. Soon after the end of World War II, the League of Nations met in 1946 in London, for what would be its last regional conference, to review the Mexico Draft.[footnoteRef:37] The outcome of this conference was the London Draft, which changed the international taxing standards away from the source state and back to the resident state of the enterprise.[footnoteRef:38] According to the first paragraph of the 1946 London model: [37: HOLMES, supra note 30, at 57.] [38: Id.]

(1) Income derived from any industrial, commercial, or agricultural enterprise and from any other gainful occupation shall be taxable in the State where the taxpayer has a permanent establishment.(2) If an enterprise in one State extends its activities to the other State without possessing a permanent establishment therein, the income derived from such activities shall be taxable only in the first State.[footnoteRef:39] [39: See League of Nations, Fiscal Committee: Report on the Work of the Tenth Session of the Committee, held in London from March 20th to 26th, 1946 (C.37.M.37.1946.II.A).]

Thus, in countering the Mexico Draft, the London Draft posits that continuous or regular business transactions without a fixed place of business would not subject the foreign enterprise to the source-state taxing jurisdiction.[footnoteRef:40] [40: SKAAR, supra note 2, at 90.]

However, neither the Mexico nor London Drafts had much influence on the definition of PE in bilateral treaties.[footnoteRef:41] During the first decade after the London regional conference, many bilateral tax treaties were concluded with PE definition that differed from the model conventions.[footnoteRef:42] Moreover, when the League of Nations dissolved in the 1946, the review and development of the London Draft was left to the successor organization, the United Nations (UN).[footnoteRef:43] The UN delegated this task to the Economic and Social Council, which established a Fiscal Committee to continue the work on the draft tax treaty agreements.[footnoteRef:44] But by 1954, the Commission failed to take initiative in advancing the work on developing the draft treaty agreement.[footnoteRef:45] This role was then taken up by the Organisation for European Economic Co-operation (OEEC), which was formed in 1948 as a result of the Marshall Plan to help promote postwar economic recovery and development.[footnoteRef:46] The OEEC established its own Fiscal Committee in 1956 to continue work on a model draft treaty. And from 1959 to 1961, the Committee prepared reports for its new model draft treaty.[footnoteRef:47] [41: Id. at 95.] [42: Id.] [43: HOLMES, supra note 30, at 57-58.] [44: Id.] [45: Id.] [46: OECD, http://www.oecd.org/general/organisationforeuropeaneconomicco-operation.htm (last visited February 25, 2014).] [47: HOLMES, supra note 30, at 58.]

D. The OECD takes over as the main international organization that drafts and publishes model tax treaties and publishes its first Model Tax Convention in 1963

In the interim, the OEED rebranded itself in 1960 as the Organisation for Economic Co-operation and Development (OECD)[footnoteRef:48], which is today the main international organization that publishes and updates model tax treaties to serve as templates for bilateral tax negations between countries.[footnoteRef:49] Its first model tax treaty, resulting from the Fiscal Committees work in 1956, was the 1963 Draft Double Taxation Convention on Income and Capital (OECD Model Tax Convention).[footnoteRef:50] But it soon became apparent in the early 1970s that the 1963 draft model was inadequate to address rising international fiscal relations, perplexing tax systems, and emerging businesses and sectors.[footnoteRef:51] The OECD Fiscal Committee then began revising the 1963 model based on prior draft treaty agreements among countries. The result was the 1977 Model Draft Treat Agreement, which became the standard template for bilateral tax negotiations between two nations.[footnoteRef:52] [48: Id. The name change was likely an attempt to remove the glaring Eurocentric nature of its original name.] [49: OECD, http://www.oecd.org/tax/treaties/oecdmtcavailableproducts.htm (last visited February 25, 2014).] [50: The model tax convention that the OECD organization promulgates is the leading framework used by developed nations in their tax treaty negotiations. See OECD, http://www.oecd.org/general/organisationforeuropeaneconomicco-operation.htm (last visited February 25, 2014).] [51: HOLMES, supra note 30, at 58.] [52: Id.]

Despite the revision, the 1977 model draft agreement, like its 1963 predecessor, was written mostly by developed nations and reflects the business interests of such economies.[footnoteRef:53] According to Holmes, when one of the parties to a draft treaty agreement is a developing country, the OECD draft treaty can produce a one-sided result that usually requires the source country (likely the developing country) to give up its tax revenue when double taxation would otherwise occur.[footnoteRef:54] This is because when developing countries trade with developed countries, the net income usually flows from the former to the latter. Thus, the former will generally be the loser.[footnoteRef:55] Professor McIntyre explains the disillusionment of developing countries with the OECD model in this way: [53: Id. at 59. ] [54: Id.] [55: Id.]

The widespread success of the OECD model in the 1970s provoked a reaction from developing countries. Those countries, being outside of the OECD, were excluded from effective participation in the design of the model. Under the League of Nations, the developed countries were the dominant force in designing a model convention. Only in the Mexico draft were the interests of the developing countries given high prominence. Still, the developing countries were represented in the process of approving model conventions. With the capture of the model treaty process by the OECD, the participation by developing countries ended. They were disenfranchised at a time when the number of developing countries was increasing markedly, due in large part to the collapse of colonialism in Africa and Asia after World War II.[footnoteRef:56] [56: Michael J. McIntyre, Developing Countries and International Cooperation on Income Tax Matters: An Historical Review 6 (2005) (unpublished comment, on file with the Wayne State University Law School).]

E. In response to the OECD Model Tax Convention, the United Nations produced the 1980 UN Model Treaty to better serve the interests of developing countries

The developing countries responded to the perceived unfairness of the OECD model by developing their own model convention under the United Nations.[footnoteRef:57] On August 4 1967, the Economic and Social Council, one of the UNs principal organ institutions, passed a resolution requesting the Secretary-General to establish an ad hoc working group of tax experts to represent the interest of both developed and developing countries.[footnoteRef:58] In 1968, the Secretary-General responded to the resolution and established the Ad Hoc Group of Experts on Tax Treaties between Developed and Developing Countries. The group comprised of tax experts from 20 countries and was assisted by international organizations such as the International Monetary Fund, the International Fiscal Affairs Association, the Organization of American States, and the International Chamber of Commerce.[footnoteRef:59] In principle, these government officials were to act in their individual expertise and not as a representative of their countries.[footnoteRef:60] [57: Note that the UNs predecessor, the League of Nations, was the organization that had originally developed the 1927 Draft Convention.] [58: McIntyre, supra note 56, at 6.] [59: HOLMES, supra note 30, at 60.] [60: Id.]

Through a long process, the UN Secretariat in 1979 finally published a Manual for the Negotiation of Bilateral Tax Treaties between Developed and Developing Countries, which were based on the guidelines provided by the Ad Hoc Group of Experts.[footnoteRef:61] The manual guided the UN to develop the United Nations Model Double Taxation Convention between Developed and Developing Countries that was published in 1980 (UN Model Convention).[footnoteRef:62] The UN Model Convention, like its OECD counterpart, included a model convention and Commentary, both of which were prepared and approved by the Ad Hoc Group of Expert.[footnoteRef:63] However, the UN Model Convention departed from the OECD model on several key points. Notably, it modified the definition of PE to grant the source country some tax revenue from business income and provided that reducing a countrys statutory withholding rates will be done through bilateral negotiations. Although no specific target withholding rates were specified in the 1980 model, the hope was that treaties based on the UN model would grant the developing countries more favorable withholding rates than the OECD model on passive investment income, such as royalties, dividends, and interest.[footnoteRef:64] [61: McIntyre, supra note 56, at 7.] [62: Id.] [63: Id; see also United Nations Department of International Economic and Social Affairs, United Nations Model Double Taxation Convention between Developed and Developing Countries (1980). ] [64: McIntyre, supra note 56, at 7]

Since the 1980 UN Model Treaty, the OECD published revised versions of its model draft agreement in 1992, 1994, 1995, 1997, 2000, 2003,[footnoteRef:65] and more recently, in 2005[footnoteRef:66], 2008[footnoteRef:67], and 2010[footnoteRef:68]. In response, the UN model was updated in 2001[footnoteRef:69] and 2011.[footnoteRef:70] [65: Id.] [66: Organization for Economic Cooperation and Development (OECD), Model Double Taxation Convention on Income and Capital 2005, available at: http://www.oecd.org/tax/treaties/35363840.pdf.] [67: Organization for Economic Cooperation and Development (OECD), Model Double Taxation Convention on Income and Capital 2008, available at: http://www.oecd.org/tax/treaties/42219418.pdf] [68: Organization for Economic Cooperation and Development (OECD), Model Double Taxation Convention on Income and Capital 2010, available at: http://www.oecd.org/tax/treaties/47213736.pdf.] [69: United Nations Department of International Economic and Social Affairs, United Nations Model Double Taxation Convention between Developed and Developing Countries (2001), available at: See http://www.un.org/esa/ffd/documents/DoubleTaxation.pdf.] [70: United Nations Department of International Economic and Social Affairs, United Nations Model Double Taxation Convention between Developed and Developing Countries (2011), available at: See http://www.un.org/esa/ffd/documents/UN_Model_2011_Update.pdf.]

F. United States and other nations have developed their own model tax treaties

Instead of relying solely on the OECD or UN Model Tax Convention, some countries have developed their own model treaty for use in bilateral negotiations. For example, the United States has a fairly robust model treaty, the United States Income Tax Convention, which was lasted updated in 2006.[footnoteRef:71] According to Holes, the US model treaty reflects the interest of the United States as a capital exporting country.[footnoteRef:72] In doing so, the model treaty can disadvantage developing nations who enter into bilateral treaties with the US based on its model.[footnoteRef:73] To Holmes, the resulting one-sided relationship is evident in: [71: Reuven S. Avi-Yonah and Martin B. Tittle, The New United States, Model Income Tax Convention, 6 IBFD BULLETIN FOR INTERNATIONAL TAXATION 224 (2007). ] [72: HOLMES, supra note 30, at 62.] [73: Id.]

[1] the models general subservience to US domestic law . . . [2] the embracing of all US citizens as tax residents of the United States (which is also a part of US domestic law);[3] the broad notion of business profits;[4] the taxation of:[i] profits of shipping and air transport operators;[ii] dividends paid by US regulated investment companies and real estate investment trusts;[iii] artistes and sportspersons;[iv] social security payments, annuities, alimony and child support payments[5] the limitation on benefits available under US DTAs;[6] the mechanism of credit relief for double taxation; and [7] exchange of information and administrative assistance.[footnoteRef:74] [74: Id. at 6263.]

Other countries have also developed their own model treaties to base their bilateral negotiations. Among them are Croatia, Malaysia, Mexico, Peru, and Sweden.[footnoteRef:75] [75: Id. at 63.]

G. The focus of this article is to discuss the recent proposals to change the definition of PE under the OECD Model Tax Convention

Despite the importance of the UN Model Treaty and the various national model treaties, this article will focus only on the OECD Model Tax Convention. Particularly, I will discuss the PE definition under the current OECD Model Tax Convention and will discuss the recent 2012 proposals to revise and clarify the PE definition.Nevertheless, the issues of fairness, effectiveness in preventing double taxation, and of course, the disparate effects on developed versus developing nationsthe same issues that prompted the development of the UN Model Treatyare still relevant to this pending discussion to change the PE definition. In this article, I hope to address whether the recently proposed revisions to the OECD Model Convention are wholly consistent with the goals of international tax law. And if not, I hope to identify areas for future revisions that would help the OECD better achieve these goals.

II. DEFINITION AND INTERPRETATIONAL ISSUES REGARDING PERMANENT ESTABLISHMENT UNDER THE OECD MODEL CONVENTION

Under the OECD Model definition, there are two legal theories upon which a PE may be found. Individuals and business entities (herein referred to as enterprises) from a foreign state is deemed to have a PE in the hosting state if the enterprise satisfies either a fixed place of business test or an agency-relationship test.[footnoteRef:76] [76: Jinyan Li, The Concept of Permanent Establishment in Chinas Tax Treaty, 7 BERKELEY J. INTL L. 120, 121 (1989).]

A. The fixed place of business theory is one of the legal theories under which a PE could be created

The fixed place of business test is one of the legal theories under which a PE could be created. According to the OECD Model Convention, there are three conditions before a PE is established under the fixed place of business theory and hence would make an enterprise subject to the taxing jurisdiction of the hosting state.[footnoteRef:77] According to Article 5(1), there must be: [77: Id.]

(1) a place of business (i.e. a physical premise like a facility); (2) the place of business must be fixed (i.e. the place must be established at a distinct site with a certain degree of permanence); and(3) the enterprise must carry its business through this fixed place of business.[footnoteRef:78] [78: Organization for Economic Cooperation and Development, Model Double Taxation Convention on Income and Capital 2010, OECD Publishing, art. 1 [herein referred as OECD Model].]

In Article 5(2), the OECD Model enumerates the following physical sites that constitute a PE: a place of management, a branch, an office, a factory, a workshop, a mine, an oil or gas well, a quarry, or any other place of extraction of natural resources.[footnoteRef:79] As these examples suggest, for a PE to exist, the enterprise must establish a physical facility or presence in the hosting country. However, these facilities do not need to be attached to the soil to be fixed places of business.[footnoteRef:80] For example, some countries have held that floating-restaurants or ship-museums can establish PEs.[footnoteRef:81] Moreover, the physical facility need not be stationary in that such facilities are tied to a specific geographic point.[footnoteRef:82] The Indian courts in Fugro Engineers BV v. ACIT concluded that a company that carried out activities onboard an Indian vessel in which travelled to different geographic points within India had established a PE.[footnoteRef:83] [79: Id. at art. 5(2).] [80: See OECD, Committee on Fiscal Affairs, Commentary on Article 5 Concerning the Definition of Permanent Establishment, 5, at 4 (July 2010), available at http://www.keepeek.com/Digital-Asset-Management/oecd/taxation/model-tax-convention-on-income-and-on-capital-2010/commentary-on-article-5-concerning-the-definition-of-permanent-establishment_9789264175181-39-en.] [81: Tiiu Albin, Problems with Permanent Establishments: Problems in Determining Permanent Establishment on the Basis of Article 5(1) OECD MC 2, Ttn-taxation.net, http://www.ttn-taxation.net/pdfs/prizes/TiiuAlbinEssay.pdf (last visited Feb. 2, 2013).] [82: Leonardo F.M. Castro, Problems Involving Permanent Establishments: Overview of Relevant Issues in Todays International Economy, 2 GLOBAL BUS. L. REV. 125, 131132 (2012).] [83: Id.]

Article 5(2) also addresses mines, oil wells, and other places of natural resource extraction.[footnoteRef:84] While these enterprises often span large geographic areas within a country, they constitute a single place of business, giving rise to only one, not multiple PE for purposes of taxation.[footnoteRef:85] [84: OECD Model, supra note 78, at art. 5(2).] [85: Castro, supra note 82, at 133.]

Finally Article 5(3) provides that building sites, construction sites, and installation projects can be deemed to be a PE if they lasts more than twelve months.[footnoteRef:86] [86: OECD Model, supra note 78, at art. 5(3).]

B. The agency-relationship theory is the second legal theory under which a PE could be created

1. Establishment of PE for foreign enterprise depends on whether the agent is dependent or independent

Even if a foreign enterprise does not have a fixed place of business in the hosting country, an enterprise may nonetheless establish a PE if it has a dependent agent operating in the hosting country. An agent is considered dependent if he or she acts on behalf of the enterprise and habitually exercises authority to conclude contract on the enterprises behalf. If so, then any activities undertaken by the agent can establish a PE for the enterprise that employs or uses the services of the agent.[footnoteRef:87] [87: OECD Model, supra note 78, at art. 5(5).]

The rationale for this dependency agency test is simple. A foreign enterprise can do business by choosing either between performing the business activity itself or having the business be done through an agent.[footnoteRef:88] In the latter case, the enterprise does not depend on, and may not even need, a right to use a fixed place of business, which under the OECD definition would give rise to a PE.[footnoteRef:89] And if the validity of PE taxation depended solely on whether the enterprise had a fixed place of business, then the enterprise could easily circumvent PE taxation by sending legions of agents to do business on its behalf in the foreign jurisdiction.[footnoteRef:90] The concept that an agent, under the right conditions, acting on behalf of an enterprise may constitute a PE for the enterprise is so well established that it could sometimes be applied to establish a PE even where the treaty lacks an agency clause.[footnoteRef:91] [88: SKAAR, supra note 2, at 463.] [89: Id.] [90: Id.] [91: Id. See also Landsskatteretten LSR (Danish Administrative Tax Tribunal) November 29, 1982, 1982- 3-675, published in MEDDELELSER FRA LANDSSKATTERETTEN 1983-I 40 (stating that to the extent that it is sometimes considered to apply even if the treaty does not have an agency clause). ]

However, the OECD does not contemplate that all agency relationship can form a PE for the enterprise. Article 5(6) exempts from PE taxation certain enterprises that execute business through brokers, general commission agents, or other independent agents that cannot conclude contracts on behalf of the enterprise, provided that these agent acts in the ordinary course of his or her business.[footnoteRef:92] Whether an agent acts in the ordinary course of business depends on customary business practices, facts, and circumstances.[footnoteRef:93] But generally, if an independent agent can habitually conclude contracts in the name of the enterprise for transactions relating to the business of the enterprise rather than his or her own business, then the agent is deemed to act outside the ordinary course of business and therefore would create a PE for the enterprise.[footnoteRef:94] Finally, Article 5(7) expressly exempts subsidiaries from creating a PE for the parent company and vice versa.[footnoteRef:95] In short, the distinction between a dependent agent (which would create a PE for the enterprise) and an independent agent (which would not) is based on whether the agent can habitually exercise authority to conclude contracts in the name of the enterprise. Of course, the phrase in the name of the enterprise refers to the ability of the agent to conclude contracts on behalf of the enterprise based on judicial interpretations of agency. It does not literally require for the foreign enterprise to be named as a party in the contract, since a contract may be binding on a foreign enterprise even if the enterprise is not listed as a party.[footnoteRef:96] [92: OECD Model, supra note 78, at art. 5(6). Also, even the presence of a purely independent agent would not allow an enterprise to escape PE taxation if the enterprise has a fixed place of business in the hosting country. After all, the fixed place of business test and agency test are both independent bases for establishment of a PE, irrespective of each other. Several international courts have upheld this principle. For example, the German Supreme Court held that a travelling agency with employees constituted a PE for the agency because it had fixed offices in the country, even though the employees could not conclude contracts on behalf of the agency. In another case, the Norwegian Ministry of Finance considered whether a Norwegian enterprise with a sales office in Germany operated by an agent constituted a PE for the Norwegian enterprise. The Ministry of Finance determined that because while the agent did not constitute a PE for the enterprise, the enterprise nevertheless had a fixed office that would result in PE taxation by Germany. As such, the enterprise could be taxed by Germany and losses were not deductible against Norwegian income. Finally, a South African court decided the interesting issue of whether the fixed offices of independent agents of an enterprise could constitute a PE for the enterprise, even though the agents themselves would not. The court decided that using independent agents to satisfy the fixed places of business test was not allowed. The enterprise itself must have a fixed place of business in the hosting country. SKAAR, supra note 2, at 468. See also, David Feuerstein, The Agency Permanent Establishment in Permanent Establishments, in INTERNATIONAL AND EU TAX LAW 105, 108 (2011) (stating that the agency clause analysis is only relevant if no PE exists under the fixed place of business test because the latter is sufficient to create a PE for the enterprise).] [93: Roy Rohatgi, Basic International Taxation, in 1 PRINCIPLES OF INTERNATIONAL TAXATION 1, 134 (2005).] [94: Id.] [95: OECD Model, supra note 78, at art. 5(7).] [96: Paragraph 32.1 of the 2010 OECD Commentary.]

2. There are many interpretational issues regarding the distinction between dependent and independent agent

But clear as the distinction between dependent and independent agents may sound, there are many interpretational issues not covered under the current OECD Model Convention[footnoteRef:97], some of which will be addressed in the upcoming revision of the OECD Model Convention that I will discuss in the next section. [97: Despite the genuine tax policies behind the agency clause, some tax practitioners even advocate abolishing of the clause because of its ambiguous wording and application. See Feuerstein, supra note 92, at 108.]

As a preliminary issue, the concept of an agent is used and understood differently between civil law and common law countries.[footnoteRef:98] In civil law countries, there is like in the OECD Model Convention, a distinction between dependent and independent agent. In the case of the dependent agent, the agent acts in the name of the foreign enterprise in dealing with third parties and therefore binds the enterprise to contracts with third parties. In contrast, the independent agent acts in its individual name and cannot bind the foreign enterprise to contracts with third parties.[footnoteRef:99] In common law countries, there is no such distinction between dependent and independent agent; the acting of the agent on behalf of the enterprise binds the latter to contracts with third parties.[footnoteRef:100] This is the case even if the third party does not know that the foreign enterprise exists when entering into a contract with the agent.[footnoteRef:101] Thus, given the distinction in the concept of the agent between civil and common law countries, bilateral tax treaties between two such countries may define an agent differently from how both countries apply that concept domestically.[footnoteRef:102] This disjunct between the concept of the agent as used in a tax and non-tax context, especially in light of the OECDs lack of clear guidance on the term, is the basis for much interpretational issues over the meaning of the term and whether an agent would create a PE for its foreign enterprise.[footnoteRef:103] [98: Id at 109.] [99: Id. In a civil law country, a subsequent agreement would need to be made between the foreign enterprise and the independent agent in order to bind the enterprise to contracts made by the agent with third parties. Id.] [100: Id.] [101: Id.] [102: See G. Persico, Agency Permanent Establishment under Art. 5 of the OECD Model Convention, 28 INTERTAX 66, 67 (2000) (stating that ideally, the agency concept should be applied in tax treaties similar to how it is used by countries domestically).] [103: See Feuerstein, supra note 92, at 108.]

As an illumination of this confusion, consider the requirement that a dependent agent must habitually exercise the authority to conclude contracts in the name of the enterprise. The OECD Model Convention is unclear whether such authority refers to an internal authority or an external authority.[footnoteRef:104] As defined, internal authority refers to the authority expressly granted by a foreign enterprise to its agent, whereas external authority refers to the authority that a reasonable third party would assume to exist when it concludes a contract with the agent.[footnoteRef:105] In common law terms, internal authority is analogous to actual authority, while external authority is analogous to apparent authority.[footnoteRef:106] In civil law countries, the external authority concept is most relevant because the interaction between third parties and the agent can relate to whether the agent is dependent (acting in the name of the enterprise) or independent (not acting in the name of the enterprise), which as discussed above, is a relevant distinction for determining agency under civil law. In contrast, in common law countries, internal authority is more relevant because even if the third party does not know about the foreign enterprise, the contract can still be binding on the enterprise.[footnoteRef:107] [104: Id.] [105: SKAAR, supra note 2, at 498.] [106: Id. For a case lending support to this analogy, see UK Court of Appeal in Hely-Hutchinson v. Brayhead Ltd., 1 Q.B. 549, 573 C.A. (1968).] [107: See Feuerstein, supra note 92, at 112. An older IRS ruling seems to emphasize the importance of internal authority in U.S. international tax treaties. The Service ruled that external authority alone, without internal authority, is insufficient to constitute PE for the foreign enterprise. See Rev. Rul. 63-113, 1963-1 C.B. 410.]

Nevertheless, the OECD Model Convention does not clarify whether the phrase authority to conclude contracts refers to internal (actual) or external (apparent) authority.[footnoteRef:108] And due to the differences between civil law and common law notions of agency, this lack of clarity may cause much confusion. For example, assuming that the phrase refers to an internal, or actual, authority, then it does not matter whether or not the agent operates in its own capacity or under the banner of the enterprise. The agent acting with actual authority will always create a PE for the enterprise, a rule that would contradict civil law requirements of also acting with apparent authority. In contrast, if the phrase refers to an external, or apparent, authority, then the agent must be acting under the banner of the foreign enterprise at all times to create a PE. This rule is then contrary to common law notions that a master must generally answer for its agent, regardless of how the agent portrayed itself out to third parties. [108: SKAAR, supra note 2, at 499.]

Another interpretational issue regarding the agency concept under the OECD Model Convention relates to the definition of a binding contract for the foreign enterprise. The Commentary to the Model Convention states that an agent may create a PE for the enterprise if its actions are binding for the enterprise.[footnoteRef:109] But the Commentary does not clarify whether binding means legally binding or economically binding.[footnoteRef:110] This distinction is mostly relevant in civil law countries where agency depends on whether the agent is dependent or independent. Even if the agent is independent and therefore acts in its individual capacity and not under the banner of the enterprise, the enterprise, while not legally bound by a contract, may nonetheless be bound to the contract economically because the enterprise may have formed a separate agreement with the agent to reimburse the agent for expenses. For example, in Interhome AG, the French Supreme Administrative Court held that an agent could not be independent if it receives payments from a foreign enterprise to compensate for insufficient fees from its business activities. Therefore, in a broad interpretation of the term binding, the Court concluded that a PE exists for the enterprise because the enterprise was economically bound to the contract, even though it was not legally bound to the contract. [footnoteRef:111] Contrary to the Interhome decision, however, most civil law countries have held since then that the term binding must be legally binding on the enterprise to constitute a PE. [footnoteRef:112] Even the French Supreme Administrative Court later adopted this view in Zimmer Ltd.[footnoteRef:113] [109: Id.] [110: Feuerstein, supra note 92, at 114.] [111: See Interhome AG (Conseil dEtat, No. 224407 (June 20, 2003)).] [112: Hans Pijl, Agency Permanent Establishments: In the name of and the Relationship between Article 5(5) and (6), BULLETIN FOR INTERNATIONAL TAX, Jan. 2003, at 7.] [113: Feuerstein, supra note 92, at 114.]

Nevertheless, the interpretation of binding remains a point of confusion. For example, the South African and Swiss branch offices of the International Fiscal Association, a non-governmental organization that provides guidance on international tax matters, still take the view that the term binding includes cases where the enterprise is economically bound by the contract.[footnoteRef:114] [114: Pijl, supra note 112, at 6.]

Finally, there is an interpretational issue over the circumstances where certain independent agents, such brokers or general commission agents (commissionaires), may create a PE for the enterprise. As a preliminary matter, brokers, commissionaires, and other independent agents of similar status often engage in entrepreneurial activities separate from the foreign enterprise and cannot create a PE for the enterprise.[footnoteRef:115]The Commentary also clarifies that whether an agent is independent depends on whether the agent receives such detailed instructions or comprehensive control from the enterprise that the agent could not be considered independent.[footnoteRef:116] Moreover, whether the agent assumes entrepreneurial risks is a factor for independency.[footnoteRef:117] [115: Paragraph 36 of the 2010 OECD Commentary.] [116: Paragraph 38 of the 2010 OECD Commentary.] [117: Id.]

Despite these factors, the Model Convention does not proffer positive examples of what constitutes a dependent agent versus an independent one.[footnoteRef:118] In addition, the factor emphasizing the detail of the instruction or the comprehensiveness of the control may sometimes suggest independency, not dependency.[footnoteRef:119] For example, the OECD Model Convention does not consider cases where the enterprise provides such detailed instruction to the agent such that the latter lacks authority and serves simply as an executor of the enterprises administrative tasks.[footnoteRef:120] In these cases, some tax professionals argue that the agent should be considered an independent one because it is given little business judgment to exercise on behalf of the enterprise and is confined by the instructions.[footnoteRef:121] Professor Skaar, for example, argues for a business activity test where an agent that performs key business functions on behalf of the enterprise such as locating customers, explaining contractual conditions to consumers, and concluding the contract for the enterprise, should constitute a PE for the enterprise. Agents that receive detailed instructions as to perform merely secondary or administrative functions for the enterprise, without more, should not constitute a PE.[footnoteRef:122] [118: Feuerstein, supra note 92, at 118.] [119: Id. at 113.] [120: Id.] [121: See SKAAR, supra note 2, at 497. ] [122: Id. See also Gary D. Sprague & Rachel Hersey, Permanent Establishments and Internet-Enabled Enterprises: The Physical Presence and Contract Concluding Dependent Agent Tests, 33 Ga. L Rev. 299, 301 (2003) (arguing that agency PE is not established unless the agent exercises business judgment to carry out contract-concluding activities).]

In short, the OECD Model Convention, up until recently, did not address many interpretational issues associated with the agency-relationship prong that is so essential in establishing a PE for a foreign enterprise. However, the recent proposed revisions to the Model Convention sets to clarify some of these issues, as I will discuss in the next section.

3. Certain business activities are exempted from the PE definition

As a side point, the OECD Model Convention exempts certain business activities undertaken by the enterprise in the hosting country from constituting a PE, even though the activity is carried on through a fixed place of business or conducted by a dependent agent who can conclude contracts on behalf of the principal.[footnoteRef:123] These activities are characterized as preparatory or auxiliary in nature.[footnoteRef:124] [123: OECD Model, supra note 78, at art. 5(4).] [124: Id.]

Article 5(4) enumerates the following activities as preparatory or auxiliary: (i) using the enterprises facilities solely for storage, display, or delivery of goods or merchandise, (ii) maintaining a stock of goods or merchandise solely for storage, display, or delivery, (iii) maintaining a stock of goods or merchandise solely for processing by another enterprise, (iv) maintaining a fixed place of business solely for purchasing goods or merchandise or collecting information, (v) maintaining a fixed place of business solely for carrying on any other activity of a preparatory or auxiliary character, or(vi) maintaining a fixed place of business solely for any combination of activities mentioned above.[footnoteRef:125] [125: Id.]

III. THE OECD RECENTLY PROPOSED REVISIONS TO THE DEFINITION OF PERMANENT ESTABLISHMENT.

On October 12, 2011, the OECD released a public discussion draft outlining proposed revisions to the Commentary section of Article 5 of the OECD Model Convention, which is the section that defines the concept of PE. Since then, the OECD has released multiple public discussion drafts, with the most recent being October 19, 2012.[footnoteRef:126] These discussion drafts and the comments received will ultimately form the basis for the updated OECD Model Convention that will likely be published in 2014.[footnoteRef:127] For purposes of this section, I will first discuss the proposed revisions flowing from the October 19, 2012 Discussion Draft (herein referred to as the Discussion Draft), but will ultimately focus this comment on the revisions to the agency theory of PE, specifically the revisions to the Commentary that explain the meaning of to conclude contracts in the name of the enterprise. [126: See OECD, OECD MODEL TAX CONVENTION: REVISED PROPOSALS CONCERNING THE INTERPRETATION AND APPLICATION OF ARTICLE 5 (PERMANENT ESTABLISHMENT), OECD Publishing, October 19, 2012, available at: http://www.oecd.org/ctp/taxtreaties/PERMESTTreaty_Policy_Working_Group.pdf (herein referred to as Discussion Draft)] [127: Ernst and Young, OECD Proposes Changes to Commentary to Model Tax Convention Regarding Permanent Establishments, INTERNATIONAL TAX ALERT, Nov. 2012, at 4, available at: http://www.ey.com/Publication/vwLUAssets/OECD_revises_Commentary_to_Model_Tax_Convention_draft/$FILE/OECD_releases_to_Model_Tax_Convention.pdf.]

A. Revisions to the fixed place of business theory to clarify what it means to be at the disposal of the enterprise

As stated, the fixed place of business is one of two main ways an enterprise can create a permanent establishment in the hosting country (the other being the agency-relationship theory). The recent Discussion Draft proposes to revise the Commentary to clarify what it means for a fixed place of business to be at the disposal of the enterprise. The current Commentary to Article 5 states that an enterprise may establish a PE in a hosting country if it has a fixed place of business that is at the disposal of the enterprise.[footnoteRef:128] To address the ambiguity of this phrase, the recent Discussion Draft states that whether or not a place of business can be at the disposal of the enterprise will depend on the extent of the of the enterprise at that location and the activities that it performs there.[footnoteRef:129] Hence, a fixed place of business will be at the disposal of the enterprise where: (1) that enterprise has an exclusive legal right to use a particular location which is used only for carrying on that enterprises own business activities (e.g. where it has legal possession of that location); or (2) that enterprise is allowed to use a specific location that belongs to another enterprise or that is used by a number of enterprises and performs its business activities at that location on a continuous basis during an extended period of time.[footnoteRef:130] The Discussion Draft qualifies factor (2) by stating that the at the disposal rule shall not apply to where the enterprises presence at that location is so intermittent or incidental that the location cannot be deemed a place of business of the enterprise (i.e. where employees of an enterprise have access to an associate enterprises premise which they often visit but do not work in for an extended periods of time).[footnoteRef:131] [128: Paragraph 4.2 of the 2010 OECD Commentary.] [129: Discussion Draft, supra note 126, at 6.] [130: Id.] [131: Id.]

The Discussion Draft also contemplates other scenarios where a place of business is not at the disposal of the enterprise. For example, the Discussion Draft explains that a location in which is owned and operated by a contract manufacturer who assembles parts for an enterprise does not, by itself, establish a PE for the enterprise.[footnoteRef:132] The reasoning is that the enterprise does not have (1) an exclusive legal use to the property and (2) does not perform business at the property on a continuous basis during an extended period of time.[footnoteRef:133] [132: Id. at 9.] [133: Id.]

B. Revisions to the agency-relationship theory to clarify the meaning of the phrase to conclude contracts in the name of the enterprise

Also in its revision, the drafters of the Discussion Draft noted several of the issues regarding the interpretational ambiguity of the agency concept. First, it identified the confusion over whether the term binding means legally or economically binding (see accompanying footnote for the Discussion Drafts illustration of this issue).[footnoteRef:134] Second, it noted the discussion among the drafters over whether a dependent agent PE could exist where it was established that the particular arrangement was entered into did not make business sense and was for the primary purpose of escaping the creation of the PE.[footnoteRef:135] Third, the drafters identified the issue over whether Paragraph 6 of the Commentary, which exempts brokers, commissionaires, and similar independent agents from the definition of PE, applied only to such agents that did not conclude contracts in the name of the enterprise.[footnoteRef:136] Finally, the drafters noted the lack of guidance on the meaning of entrepreneurial risk, which is a factor in determining whether an agent is of an independent status (see accompanying footnote for Discussion Drafts mention of a historic proposal to clarify this term).[footnoteRef:137] [134: Discussion Draft, supra note 126, at 3334. To illustrate the issue over whether the term binding means legally or economically binding, the Discussion Draft included an example that was developed in preparation for the IFA 2009 Congress:PARENTCO, a company resident of State R, and SUBCO, a company resident of State S, are parts of the same multinational group. Until 2008, SUBCO is the distributor in State S of the products of PARENTCO, which it buys from its parent and resells in State S. In 2008, the distributorship arrangement is replaced by a contract of commissionaire. Under that contract, SUBCO will act as an agent of PARENTCO to sell in State S products owned by PARENTCO. As such, SUBCO will accept orders, submit quotes and documents in tender offers and conclude sales contracts for PARENTCOs products and will be authorized to engage in price negotiations and to grant discounts or terms of payment with current or new customers without specific prior approval by PARENTCO. In jurisdictions where agency law recognizes indirect representation, the contract will provide that SUBCO is acting as a commissionaire. In jurisdictions where this is not possible, each contract concluded by SUBCO with a customer will specifically provide that the contract is exclusively between the parties and does not bind any other party, including PARENTCO. In a separate agreement, PARENTCO has agreed to fully reimburse SUBCO for any amount that it may be required to pay customers under its contractual liability. PARENTCO will also control the types of products that will be sold through SUBCO. Id (emphasis added). ] [135: Id. at 34.] [136: Id. at 36.] [137: Id. at 37. The Discussion Draft mentioned a historic proposal by the drafters for the 2002 OECD Model Convention to clarify the meaning of the entrepreneurial risk for purposes of Paragraph 38. The historical proposal, which the current drafters did not incorporate into the recent OECD Model Convention, was as follows: 38.7 As indicated in paragraph 38 above, another important criterion the assumption of entrepreneurial risk is a distinguishing feature of the independent agent. The character of the remuneration which an agent receives may provide a useful indication of whether (or to what extent) the agent bears the commercial risk of his activities. Factors suggesting that risk is not borne by the agent include contractual protection from losses or guaranteed remuneration. However the existence of a guaranteed stream of revenues will not be decisive where the agent is able to show that there remains a real possibility of loss as a consequence of risk borne by him in the conduct of the business. Where the overall scale of the agents business is substantial this may be suggestive of the strength of the agents position vis-a-vis his principals and hence his independence. And instances where an agent has demonstrated the strength of his position in reaching agreements with principals may provide firm evidence of independence. Id. ]

Despite flagging these issues, however, the drafters admitted that they could not a reach a consensus on most of them. As such, the drafters did very little to expressly address these issues in the upcoming revision of the OECD Model Convention. Thus, one of the few actual changes to the Commentary of Article 5 (dealing with PE) was to add an example to clarify what it means for an agent to conclude contracts in the name of the enterprise. The text of the proposal is inserted below:The Working Party recommends that the following changes be made to the Commentary on Article 5 in order to address this issue: Replace paragraph 32.1 of the Commentary on Article 5 by the following: 32.1 Also, the phrase authority to conclude contracts in the name of the enterprise does not confine the application of the paragraph to an agent who enters into contracts literally in the name of the enterprise; the paragraph applies equally to an agent who concludes contracts which are binding on the enterprise even if those contracts are not actually in the name of the enterprise. For example, in some countries an enterprise would be bound, in certain cases, by a contract concluded with a third party by a person acting on behalf of the enterprise even if the person did not formally disclose that it was acting for the enterprise and the name of the enterprise was not referred to in the contract. [the rest of existing paragraph 32.1 is moved to new paragraph 32.2] 32.2 Lack of active involvement by an enterprise in transactions may be indicative of a grant of authority to an agent. For example, an agent may be considered to possess actual authority to conclude contracts where he solicits and receives (but does not formally finalise) orders which are sent directly to a warehouse from which goods are delivered and where the foreign enterprise routinely approves the transactions.[footnoteRef:138] [138: Id. at 3435.]

In short, the only substantive revision to the Commentary to clarify the phrase authority to conclude contracts in the name of the enterprise was to add the bolded example above explaining that an enterprise could be bound by a contract concluded with a third party by an agent acting on behalf of the enterprise, even where the agent did not disclose that it was acting on the enterprises behalf and did not refer to the name of the enterprise in the contract.[footnoteRef:139] [139: Id.]

For the rest of the Article, I will focus on the proposed revision and clarification to the agency-relationship concept. In particular, I hope to identify the shortcomings of the upcoming revisions with respect to this concept. I also hope to provide suggestions for future revisions so that the Model Convention can better achieve the goals of international tax, which include among others, principles of fairness and predictability.

IV. EVALUATION OF THE OECD REVISIONS AND SOLUTIONS TO CLARIFY THE PHRASE AUTHORITY TO CONCLUDE CONTRACTS IN THE NAME OF THE ENTERPRISE Given the meager revisions to Paragraphs 32.1 and 32.2 of the Commentary (see section III above), it is needleless to say that the proposed revisions have failed to sufficiently clarify the meaning of the phrase authority to conclude contracts in the name of the enterprise.

A. The proposed revisions failed to clarify the term binding as legally binding as opposed to economically binding

First, the revisions have not clarified whether the term binding, which is a sub-requirement for an agent to establish a PE under the phrase above, means legally or economically binding. This lack clarity is quite glaring given that most courts that have addressed the issue, including the highest courts in France, Norway, and Italy, have agreed that the term refers to a legally binding arrangement.[footnoteRef:140] The drafters, however, noted that they could not reach an agreement regarding this issue of binding in light of the cases mentioned above. Instead, they claimed that adding an example where a foreign enterprise would be bound by a contract even though it would not literally mention the enterprises name.[footnoteRef:141] [140: Pijl, supra note 112, at 7.] [141: Discussion Draft, supra note 126, at 35.]

According to this authors view, the drafters inability to clarify the term binding as legally binding reflects a certain degree of unreasonableness and confusion on behalf of the drafters. Moreover, their inability to do so undermines the principle of predictability in international tax law. After all, the OECD Model Conventionwhile having some connection to economic and business conceptsis mostly a convention rooted in tax and legal concepts. This is apparent given that disputes arising from bilateral tax treaties based on the Convention are interpreted and decided by the respective courts in the jurisdictions of the contracting parties. And unless there is a compelling reason to give a traditionally legal term a non-legal meaning, then the legal understanding of the term must reign supreme. Here, the term binding is traditionally a legal term, understood to mean a legally binding arrangement. Specifically in the context of the agency theory of PE, the legal understanding of binding with respect to a foreign enterprise is that the enterprise may be sued by a third party that contracts with an agent who signs on behalf of the enterprise.[footnoteRef:142] Thus, by not clarifying that binding means legally binding, the drafters risk allowing parties (and even courts)[footnoteRef:143] to construe the term as economically binding, which is perhaps less predictability understood than its legal counterpart.[footnoteRef:144] This in turn, would make the understanding of a dependent agent less predictable. [142: See Societe Zimmer Ltd v. Ministre de l'Economie, des Finances et de l'Industrie, International Tax Law Reports 12 ITLR 739 (2010). ] [143: Before correcting itself in the Zimmer Ltd. decision, the French Supreme Administrative Court interpreted binding as economically binding. See Interhome AG (Conseil dEtat, No. 224407 (June 20, 2003)).] [144: For example, while developing nations often import their legal systems from developed nations and therefore their understanding of legally binding may be more in unison, courts in developing nations may use the opportunity to apply a nebulously-defined concept like economically binding to impose a PE where there otherwise would not be one.]

To illustrate the unpredictability of applying the term binding as an economic term, consider the following example. Suppose a large American software company wishes to sell its products in a growing international market, like China. It employs a general commission agent in the country to advertise, take orders, and conclude contracts on the company's behalf. Otherwise, the agent is completely independent and assumes its entrepreneurial risk. But also pursuant to the arrangement, the software company reimburses the agent for costs associated with performing its tasks, such as travel, lodging, and other expenses, so that the agent can realize profit from the arrangement. Under the legal understanding of binding, the agent does not constitute a PE because of its independent status and the traditional exemption of commissionaires from creating a PE because of the lack of a legal binding obligation between the third parties and the foreign enterprise that hires the agent. But under the economic understanding of binding, the foreign American enterprise may nonetheless have a PE in the country due to its obligation to compensate the agent for expenses associated with performing business tasks for the enterprise. As such, the commissionaire shield that once protected the enterprise from realizing a PE under the legal understanding of binding is now pierced because under the economic arrangement, the agent can no longer be considered an independent agent, but a dependent one. Thus, as shown in the example above, the economic gloss on the term binding proffers a confusing understanding of the term and undermines the predictability of international tax law. In addition, an economic understanding of binding is also at tension with legal concepts such as the commissionaire. After all, even though the former is an economic concept, it may be allowed to override a civil law concept of the commissionaire and force a PE where there otherwise would not be one. It would therefore make more sense to define binding in legal terms so that it remains consistent with legal concepts like the commissionaire. In other words, the commissionaire should not constitute a PE for the enterprise because simply, the commissionaire does not legally bind the enterprise to a contract under civil law. If the alternative understanding of the term binding was adopted, then while the commissionaire does not legally bind the enterprise, it may nonetheless economically bind the enterprise and therefore can create a PE, which is itself a legal concept. In this authors view, the latter case does not make sense.

B. The proposed revisions fail to harmonize common law and civil law elements in the Model Convention

Another issue with the proposed revision is that the clarification actually makes the Model Convention more confusing by muddling the distinction between common law and civil law elements without harmonizing the two systems. As mentioned earlier, before the revisions, the Model Convention stated that the phrase authority to conclude contracts in the name of the enterprise also binds foreign enterprises to contracts even though the agent concluded the contract not in the name of the enterprise.[footnoteRef:145] The new revision provides an example of the statement above by stating that a foreign enterprise can be bound by a contract even though the agent did not formally disclose that it was acting for the enterprise and did not include the name of the enterprise in the contract.[footnoteRef:146] In essence, the new revision simply affirms that even if an agent does not act with external (apparent) authorityeither by not mentioning the name of the enterprise or other act under the banner of the enterprisethe agent may nonetheless constitute a PE for the foreign enterprise. This revision thus expressly precludes the application of traditional civil law, which requires that an agent also exercise external (apparenty) authority before binding the enterprise to a contract. As a result, the revision solidifies the application of the common law rules. That is, an agent can bound the foreign enterprise, regardless of whether it acts with external (apparent) authority. [145: Paragraph 32.1 of the 2010 OECD Commentary.] [146: Id.]

Despite this common law rule, however, the Model Convention exempts a certain type of agent from creating a PE for the foreign enterprise. Per Paragraph 36 of the Model Convention, brokers and general commission agents (commissionaires) do not create a PE for the foreign enterprise so long as they are acting in their ordinary course of business.[footnoteRef:147] This exception comports with the civil law rule that commissionaires generally do not establish an agency for the foreign enterprise. Nonetheless, this exception for commissionaires appears inconsistent with the common law rule mentioned above. After all, the former is a hallmark exemption from agency under civil law whereas the latter would have imposed agency on commissionaires. [147: Paragraph 36 of the 2010 OECD Commentary.]

Perhaps to reconcile their co-existence in the Model Convention, it is important to examine what exempts a commissionaire from creating an agency relationship with the foreign enterprise. Per Paragraph 36, a commissionaire and any other agent of independent status will not create a PE.[footnoteRef:148] And under Paragraph 37, an agent will not constitute a PE for the foreign enterprise if he or she is independent both economically and legally and acts in the ordinary course of business.[footnoteRef:149] Thus, a commissionaire is exempt from the common law application above because of one important element: a commissionaire is an independent agent. And discussed above, an independent agent is one who cannot conclude contracts on behalf of the foreign enterprise; a dependent agent can. It must go to say then, that Paragraph 32.1 (which defines the phrase authority to conclude contracts in the name of the enterprise and applies the common law approach) must refer to dependent agents who can conclude contracts on behalf of the enterprise. [148: Id.] [149: Paragraph 37 of the 2010 OECD Commentary. ]

Although this distinction between independent and dependent agents is consistent with the civil law system, there is a slight deviation in the Model Convention. Unlike the traditional civil law, the Model Convention does not require a dependent agent to also exercise external (apparent) authority. Rather, the Convention allows a dependent agent, regardless of how it portrays its relationship with the enterprise to third parties, to constitute a PE for the enterprise. Hence Paragraph 32.1 and 36 can be reconciled. The former states that a dependent agent can create a PE whereas the latter states that an independent cannotconsistent with the rules of civil law. But again, the former has a common law twist to it. That is, the requirement of external (apparent) authority is scraped and a dependent agent will always create a PE for the enterprise. Thus, under the Model Convention, the distinction is simple in principle: a dependent agent will create PE for the enterprise and an independent agent will not create a PE for the enterprise, assuming that such agent acts in the ordinary course of business.

C. The proposed revisions should introduce a separate business sphere analysis to determine whether an agent is independent or dependent

But despite the important difference between dependent and independent agent in determining PE, the revision does not adequate clarify how to distinguish the two. For example, the proposed Model Convention defines an independent agent as a person who is not subject to detail instructions from the enterprise to the extent that it renders him or her a dependent agent. Another criterion addressed whether the agent assumes his or her entrepreneurial risk.[footnoteRef:150] [150: Discussion Draft, supra note 126, at 59.]

Perhaps the former factor (relating to providing detailed instruction) is among the most problematic and ambiguous factor in determining whether an agent is independent is the instruction factor. As mentioned earlier, providing detailed instruction to an agent does not always make the agent a dependent of the enterprise; sometimes, it may swing the opposite way. Providing detailed instruction to a person can actually evidence an independent agent. This is because sometimes the enterprise has a commercial purpose in subjecting the agent to meticulous instructions in order to limit or somehow direct the scope of his or her services, which in turn may suggest that the agent is an independent one. For example, an enterprise may wish to hire a foreign analyst in an international market to conduct research in that area. If the enterprise provides the analyst with specific instructions, such as suggested methodology, specific format required for an analyst report, and factors to consider for analysis, then that agent might be considered, absent other counteracting factors, a dependent agent and would create a PE for the enterprise. However, many enterprises have business reasons for providing specific instructions to its foreign contractors, such narrowing the scope of the project to limit service fees or standardizing practices to ensure quality of work product. But this does not suggest that the agent is somehow piece and parcel with the enterprise to justify creating an agency relationship. If anything, the agent in this scenario is hired only for a specific task and is not allowed to exercise business judgment or conduct any business for the enterprise. This arrangement, then, suggests an independent agent relationship because the detailed instructions prevented the agent from assuming responsibilities normally associated with dependent agents, such as ability to carry on the actual business or business operations of the enterprise. Therefore, given that confusion regarding the detailed instructions factor and how that factor would not always create a dependent agent, I argue that it should be scraped altogether from the Model Convention. In its place, I argue that the Convention (and its upcoming revision) should focus on refining the factors that emphasis the hallmark trait of an independent agentwhich is that the agent has a separate business from the foreign enterprise and assumes the risks and activities associated with having a separate business. Thus, to improve clarity in the upcoming Draft Convention, I propose a separate business spheres analysis where the proposed factors for determining whether an agent is independent or dependent relate to whether the agent occupies a separate sphere of business from the enterprise. Under this analysis, the Model Convention should provide certain key factors for determining what constitutes a separate business. For example, the Convention should retain its entrepreneurial risk factor as a factor for determining independency. In fact, the drafters of the upcoming Model Convention noted that in the 2002 revision, their predecessors stated that entrepreneurial risk is a distinguishing feature of an independent agent.[footnoteRef:151] Although this view is correct, the current drafters chose not to expressly highlight the importance of this entrepreneurial risk because it was only one of the factors for determining whether a person was an independent agent.[footnoteRef:152] Indeed, this risk factor is but one of the factors for determining independence. But given the importance of this test, it should have been highlighted as a consideration under a facts and circumstances test. Moreover, this risk factor need not be a stand-alone factor. The drafters could sensibly incorporate this factor into the overall theory of the business sphere test described above, which would make it a prong of the business sphere analysis. Under this consolidated business sphere approach, countries and tax courts could recognize the entrepreneurial risk factor as an important factor while also considering other aspects of what constitutes a separate business. And by consistently interpreting this risk factor, as opposed to dismissing it in favor of other factors for determining whether an agent is independent (such as the specificity of instruction factor mentioned above), tax courts will eventually develop more case law with regards to this important factor. Similar to the causation prong of the negligence analysis in American common law, the entrepreneurial risk factor may be a complex and hard to decipher facts-and-circumstances factor at first. But with more case law, this factor will be increasingly illuminated. Thus, by making the entrepreneurial risk consideration a prong of the business sphere analysis, the drafters not only create cohesion in the overall independent versus dependent agent analysis, but also can also increase the body of law interpreting entrepreneurial risk. And with more dialogue and analysis on this very important factor, there should be more predictability and fairness with regards to its interpretationimprovements that would provide a degree of consistency and assurance for businesses to conduct their international transactions, without the lingering, uncertain fear of a PE capriciously coming out of the shadows. [151: Discussion Draft, supra note 126, at 37.] [152: Id at 38.]

V. CONCLUSION

In short, the history and development of the PE concept is a complicated and controversial issue. As seen from the historic and ongoing debates between developing versus developed nations regarding its interpretation, to the disputes in the Zimmer case, the PE concept, particularly the agency-theory clause, is still far from being a cohesive concept. But even before countries and international tax courts begin to discuss the various PE issues regarding fairness to varying economies and consideration of modern technology and commerce, there should be at least a baseline understanding of what constitutes a PE. Given that the Model Convention is structured to accommodate civil law and common law elements and is based on the concept of independent versus dependent agents, the drafters need to better clarify the factors that distinguish the former from the latter. As suggested in this article, the drafters should adopt a separate business sphere analysis to determine whether an agent is independent or dependent. Under this umbrella analysis, the drafters may incorporate specific but important factors such as entrepreneurial risk. With this overarching and cohesive analysis structure then, countries and tax courts can better interpret sub-factors like entrepreneurial risk and create case law that overtime would add predictability and fairness to the understanding of PE.