Finding a tax-efficient operating structure that suits a multinational group operating in a mix of high and low tax jurisdictions brings with it a number of considerations, tax or otherwise. Clive Tietjen, Director, and Rachel Owen, Senior Manager, consider how recent events and experiences might influence the decisions made by multinationals around operating structures and in particular whether it is time for the Commissionaire model to be reborn.
A multinational looking to embrace a tax-efficient supply chain model will need to make many decisions along the way as to how to design and implement it. One of the factors will be the selection of the local business model. This article sets out some of the factors considered by organisations when looking to choose between using a Limited Risk Distributor (LRD) or a Commissionaire model and how recent events may influence management decisions.
What are these models?
To assess the applicability of each structure, it is first necessary to describe what each of the terms means.
An LRD is a distributor which acts in its own name and on its own behalf and takes legal title to the goods that it sells, but it does not take on all of the risks that a distributor might. Risks such as bad debt, holding excess stock and warranty are borne by another company (the principal) by virtue of the contractual arrangements. Since the LRD is acting on its own behalf, it does not bind the principal to the customer (ie, it does not allow the customer to sue, or be sued by, the principal).
A Commissionaire arrangement is a civil law agency concept: in civil law countries it is possible for a commissionaire to enter into a sales contract with a customer in its own name, but on behalf of and at the risk of a principal company. Such an arrangement does not result in the commissionaire binding the principal to the customer (ie, as with an LRD arrangement it does not allow the customer to sue or be sued by the principal). The closest equivalent to a commissionaire in common law countries, such as the UK, is an ‘undisclosed agent’ (though the term commissionaire will continue to be used in this article) although the position that the commissionaire does not bind the principal can be less clear under common law compared with civil law. Unlike an LRD structure a commissionaire does not take legal title to the goods sold and hence the title passes directly from the principal to the third party. For practical purposes, however, commissionaire is not significantly different from an LRD, as although the LRD takes title to the goods, the nature of the arrangement with the principal is such that the risk of holding stock on this title transfer is legally held by the principal. Accordingly, overall the risk profile of a commissionaire is similar to that of an LRD.
Which is best?
As noted above, for practical purposes, the result of using an LRD or a commissionaire is not dissimilar and as the functions and risks are similar, the level of profitability achieved under transfer pricing principles could be similar. How then should an organisation go about deciding which model to use?
In some businesses, there will be a particular commercial issue that will drive the choice and clearly this must take precedence. However, absent any particular commercial issue that sways the decision, organisations will be influenced by the tax analysis and the likely reaction of the tax authorities to the different structures.
In the 1990s, our experience was that there was a trend for commissionaires. This was largely driven by US multinationals because the absence of an inter-group sale meant that the use of a commissionaire could enable the adoption of a tax-efficient central entrepreneur model without disturbing customer relationships but also without triggering the US controlled foreign company rules (many readers will be familiar with the sub part F rules). The reaction of some tax authorities in Europe has been to resist the move to these structures. The key areas of challenge, apart from transfer pricing, on the move from one business model to another have been permanent establishment and exit charges. Exit charges are a significant topic outside the scope of this article, which now focuses on permanent establishment.
Experience of tax authorities’ reaction
As noted above, under common law, the position that a commissionaire does not bind the principal can be less clear. If it is the case that the commissionaire binds the principal, then it is very likely that the commissionaire creates a permanent establishment (PE) of the principal such that the principal becomes taxable in the jurisdiction of the PE, relating to the profits generated there.
Indeed, for the UK, the guidance provided to UK tax inspectors at INTM465040 states that:
‘Under common law, when an undisclosed agent enters into a contract, he binds the principal, and in theory the customer could sue either the agent or the principal – there is a contractual relationship between the principal and the customer.’
Our experience of dealing with the UK tax authorities is that Inspectors apply the understanding taken from the above guidance to challenge the operating models of many groups where commissionaire companies have been used, leading to time-consuming enquiries.
In addition to the approach from the UK tax authorities, there has been some confusion over the status of commissionaire in civil law jurisdictions, particularly France. In the French case, Zimmer (Conseil d’ État, 31 March 2010 no 304715 and 308525), the terms and conditions of the commissionaire agreement in force between Zimmer Limited (Principal) and Zimmer SAS (Commissionaire), and the lack of discretion given to the commissionaire in determining contracts with customers, caused the French Tax Authorities (FTA) to argue that Zimmer SAS was a dependent agent of the UK with the power to bind the UK company. The FTA thus argued that Zimmer Limited was liable for corporate tax in France for the arrangements which were under tax audit, notwithstanding the generally recognised concept of commissionaire.
This approach from the European tax authorities in arguing for the existence of a local PE combined with the desire of many multinationals to operate a consistent structure, operating model and IT system across Europe meant that, in our experience, commissionaire models tended to fall out of favour during the noughties, with LRD increasing in popularity.
Readers will be familiar with the US ‘check the box’ rules which enabled many US multinationals to treat the LRD entities as ‘look through’ entities and so manage the impact of the US CFC rules referred to above on this use of LRD’s in preference to commissionaires.
Where does that leave us now?
For the 2010 plus environment, further tax audit developments in Europe are of interest. As mentioned above, in France, the Zimmer case has been heard by the Conseil d’État who overturned the view of the lower court and ruled that Zimmer SAS did not constitute a permanent establishment of Zimmer Limited. The Conseil d’État concluded that the question of binding the principal should be addressed under French (civil) law and found conclusively that the commissionaire does not contractually bind the principal. The commissionaire cannot be deemed a permanent establishment of the principal thus putting the law back in to the position previously understood. This could have wider ranging implications for other European civil law countries where there may be less incentive from European tax authorities to challenge the commissionaire models following the outcome of the Zimmer case.
In the UK, an analysis of commercial case law suggests that the position outlined in the HMRC guidance relating to commissionaire may be contradicted by UK contract law. Under UK contract law, the starting point is that only the parties included on the contract may be bound by it. The idea of the principal being bound by the contract and sued by the customer is only possible using a contract law feature known as ‘the doctrine of the undisclosed principal’ (‘the doctrine’). The concept of the doctrine has been used in commercial situations by customers in an attempt to sue the principal, rather than the agent, in a transaction. Such arguments have also gone before the court. From Rolls-Royce Power Engineering plc and another v Ricardo Consulting Engineers Ltd ([2004] All ER (Comm) 129), it is clear that the doctrine should be tested from the understanding of the intention of the principal and commissionaire. The intention of the principal and commissionaire should be set out in the contracts entered into (both the contract between the principal and commissionaire company and the contract between the commissionaire and the customer). The doctrine could therefore be displaced using clear words in the contracts and this could enable a UK entity to enter into a commissionaire arrangement, which would not bind the principal. Following the analysis set out above, this should then prevent the creation of a PE in the UK. Our experience of HMRC officers now familiar with these structures is that they recognise the possibility of displacing the doctrine and preventing the creation of a PE.
Accordingly, the assertion by a tax authority of a PE under a commissionaire structure, on the grounds that it binds the principal in either a civil law or a common law country is one which should be capable of being managed through a proper legal analysis.
Conclusion
As noted above, unless there is a particular commercial reason to dictate which operating model to follow, it has often been tax considerations (and the risk of PE in particular) which have driven a preference for one model over another and this has encouraged many groups to adopt the LRD model. The local tax implications of each model in Europe appear to be becoming less diverse, which arguably puts the two models on a more equal footing from a tax perspective. As such, groups, which may previously have rejected the commissionaire model, may wish to rethink their position. For US groups, the proposals raised by President Obama on US taxation, although still to be finalised, are in our experience causing groups to rethink their structure. More generally, we have witnessed a recent trend in certain businesses to choose a commissionaire model over an LRD model, as it can be easier to implement from a systems perspective (although this will be fact specific) or because it can be easier to manage the supply of services.
It may well be time for the commissionaire to be reborn.
Clive Tietjen, Director, Deloitte global transfer pricing team, Reading
Rachel Owen, Senior Manager, Deloitte global transfer pricing team, Reading
