The Spanish substantialist approach to fragmented structures of business: the Dell Case, a subsidiary as Permanent Establishment Eduardo Martínez-Matosas Tax Lawyer of Gómez-Acebo & Pombo Jose Manuel Calderón Professor of Tax Law & Member of the Academic Council of Gómez-Acebo & Pombo 1.Introduction On March 15, 2012, the Spanish Central Economic-Administrative Court (TEAC) delivered its ruling on the Spanish Dell case, concluding that the activities of the Spanish subsidiary of Dell (Dell Spain) constituted a permanent establishment (PE) of a group Irish sales company (Dell Products). This ruling upheld the substantialist approach of the Spanish tax authorities with regard to post-restructuring schemes and commissioner dealings involving complex and fragmented structures for carrying out relevant economic activities in Spain. It can be said that this ruling constitutes another victory of the tax administration on the interpretation of the PE´s tax treaty clauses. During the last years, the Spanish courts have adopted the functional and substantialist approach developed by the tax authorities on the interpretation of tax treaties departing from more legalistic positions invoked by the taxpayers that try to found their positions on the OECD materials (OECD Model Convention Commentaries)1. In this sense, it should be noted that this decision has important practical implications for taxpayers and tax authorities with regard to restructuring schemes, commissioner dealings, contract manufacturing and remote business carried out in Spain by foreign companies. 1 See the General Tax Directorate´s ruling of 20 November 2008 (V2191-08 and V2192-08), the High National Court rulings of 20 May 2010 (M-Real case), and of 9 February 2011 (Borax case), and the Supreme Court decision of 12 January 2012 (Roche Vitamins case). 1 | Gómez Acebo & Pombo © SEPTEMBER 2012 2.The Facts The main facts that are established by the Court are the following: Dell’s commercial structure for EMEA and in particular for Spain was operated through several companies conforming a complex, blurred and fragmented model for carrying out the business activities of the multinational company in Spain. On the one hand, Dell Europe (Irish company) manufactured computers in Ireland. Dell Products (Irish company) purchased products from Dell Europe (Irish company), and sold them in the market through local Dell subsidiaries, under commissionaire agreements. On the other hand, Dell’s computers were sold in Spain by Dell Spain (commissionaire) under a commission agreement with Dell Products (the principal). Dell Spain sold and marketed the computers in the Spanish market in its own name but for the account of Dell Products. Dell Products’ function was the sale of computers and the management/control of their distribution in the different markets through local distributor entities, functionally characterized (and remunerated) as commissionaires, but which actually performed substantive activities, from a business perspective, beyond the mere commissionaire function. Dell Products did not have its own human resources; these were subcontracted to Dell Europe. In particular, the Spanish commissionaire (Dell Spain) was directly and actively involved in the logistics, marketing, post-sell services and administration of Dell Products’ Spanish online store. Dell Products had no employees or facilities in Spain (owned or rented). Moreover, it should be noted that the above-mentioned structure was the result of a business restructuring operation. Prior to such restructuring, the local Dell subsidiaries were responsible for the direct sale of computers, having all functions and resources. Dell Products operated through a direct sales model so that purchase orders were placed in a web or call center. Dell Spain operated as a full-fledged distributor, undertaking strategic activities in Spain until 1995, when it entered into commissionaire agreement with Dell Products to serve medium and large sized customers that required specialized and on-site attention. However, sales to Spanish small sized customers were made by Dell France through a call center and a web site. 3.The TEAC’s Decision The TEAC confirmed the position of the tax inspection, concluding that Dell Spain constituted a Spanish PE of Dell Products, both under articles 5.1 (fixed place of business) and 5.4 (dependent agent) of the Spanish-Irish Double Tax Treaty, by using the Commentaries to the OECD Model Convention (“OECD CMC”) as an interpretative guideline. This conclusion was reached despite Dell Products had no employees or facilities in Spain. The Court determined that all the sales made by Dell Products in Spain (less commissions paid to Dell Spain and other related allocable expenses) should be attributed to Dell Product’s Spanish PE. The TEAC´s ruling also followed the tax examiners approach that sales to Spanish customers that were made through the French Subsidiary of the 2 | Gómez Acebo & Pombo © SEPTEMBER 2012 Dell group should be allocated to the Spanish PE of Dell Products, inasmuch as the French subsidiary main activities and sales were carried out through or with substantial involvement of the human and material resources of Dell Spain. The division of the functions between both companies (Dell France and Dell Spain) was unclear from a legal and economic perspective, but the examiners demonstrated that the most significant economic activities were carried out in Spain. Fixed place of business The Court basically ruled that Dell Products had a fixed place of business in Spain, giving rise to a PE, through the operative settlement provided by Dell Spain’s facilities and activities, despite no formal ownership or rental of such facilities existed. OECD CMCs to Article 5 expressly foresees that a parent company can have a PE in the State where a subsidiary has a place of business (e.g. space or premises belonging to the subsidiary that is at the disposal of the parent company). Another important aspect of the resolution has to do with the characterization of the online store as an “online PE”, even though the server was situated outside Spain and no activity was performed through human means or assets located in Spain. In this regard, it should be noted that Dell Products performed in Spain activities which are economically significant -such as sales and delivery-, and that there were employees of the Dell Spain were involved in the maintenance of the online store. The Spanish tax authorities and the TEAC did not accept the application of OECD CMCs to Article 5, which states that a web site does not generate a PE in a State, unless the server is physically located in that State. The tax authorities and the Court argued that such CMCs do no apply to the case under analysis as the activities performed in Spain were economically significant (i.e., trading, selling, delivering). They also argued that Spain introduced an observation on the OECD CMCs to paras.42.1 to 42.10 of Article 5, indicating that since the OECD continues the study of e-commerce taxation, Spain will not necessarily take into consideration the aforementioned paragraphs until the OECD come to a final conclusion2. It must be pointed out that despite Spain withdrew such observation in the 2010 version of the OECD Model Convention, it can be expected that the functional and substantialist approach developed by the Spanish tax authorities would still be applicable for testing the existence of a PE in Spain. Dependent agent Furthermore, the Court ruled that Dell Products had a PE in Spain, as Dell Spain had authority to conclude contracts in its name, acting as a dependent agent. In particular, Dell Spain had authority to conclude contracts that were binding on Dell Products (even if those contracts were not actually in its name). Another important element was also that Dell Spain acted under comprehensive supervision and control of Dell Products, and its activities were not limited to those of an auxiliary character. 2 Para 45.6 of the OCDE CMC to Article 5. 3 | Gómez Acebo & Pombo © SEPTEMBER 2012 4.The authors’ comments The most controversial aspect of the TEAC’s decision is, in our view, the wide interpretation of the PE clause of the Spain-Ireland tax treaty, which largely supports the Spanish Supreme Court’s decision in Roche Vitamins3. This approach raises a number of doubts from a technical perspective. In this regard, it should be noted that the Norway’s Supreme Court came to an opposite conclusion in relation to the same business structure in Norway -Dell Products/Dell AS-, and in similar terms the French Conseil d’Etat in Zimmer; these rulings have, however, been regarded as too legalistic by the Spanish tax administration and Courts considering that a functional and substantialist interpretation of the PE clause (article 5) is more consistent with the spirit and finality of this treaty clause: a more balanced division of the tax power between the contracting States according with the activities carried out in each country. Another questionable aspect would result from the lack of debate on the interrelationship between transfer pricing rules and the PE clause within the DTTs context. Basically, the TEAC’s approach goes through a prevalent application of the PE clause, which leads to avoid the material and procedural application of the Spanish domestic transfer pricing rules. Nevertheless, in our opinion the TEAC’s position could not be deemed unreasonable, as the structure shows that the relevant economic functions, concerning the generation of value, were carried out in Spain through an operative organization, where the Spanish subsidiary played an essential role for the business success. A correct functional characterization of the entities involved would have led to a more balanced profit allocation. Thus, an accurate determination of the arm’s length remuneration for such intragroup functions or services should have allowed neutralizing or mitigating the risk of a PE approach as the one adopted by the TEAC, which ends up by attributing all the profit (all the sales) to the target market/country. This decision, together with Roche Vitamins, constitutes the second big “warning” of the Spanish Tax Authorities on low-consistent international structures in terms of substance, that imply a inaccurately balanced attribution of profits obtained in Spain, in relation to the real economic functions performed in the country. 3See Martínez-Matosas/Calderón, “Subsidiary Constituted PE, Supreme Court Rules”, Tax Notes International, vol.65, nº10, 2012, pp.743 et sequ. 4 | Gómez Acebo & Pombo © SEPTEMBER 2012