Taxation of the digital economy

The Google case – is there a permanent establishment anywhere?

The digitalisation of the economy raises tax challenges which have been part of the BEPS package discussions. The OECD is trying to obtain a global consensus on this issue, which is very difficult to obtain at the present time as recently highlighted by an interim report published in March 2018.

One of the most relevant measures for highly digitalised businesses is the change in the permanent establishment definition. Indeed, the existing tax treaties are not tailored for the digital economy, as has been recently illustrated by two decisions of the French Courts, in particular one regarding Google.

The Google case

Google Ireland provides an advertising service as part of its 'AdWords' program to its customers, including French ones.

As Google Ireland does not have any physical presence in France, it has entered into a Marketing and Services Agreement (MSA) with Google France pursuant to which the latter will provide marketing services to Google Ireland to support its sales to French customers.

As a result, Google France is acting as a service provider for Google Ireland. The MSA provides that Google France has no authority to bind Google Ireland or to sign any contract or agreement on behalf of Google Ireland. In other words, Google France was not formally involved in the sales of Google Ireland.

The French tax authorities considered that Google Ireland had a permanent establishment in France through Google France, leading to a tax reassessment of EUR 1.1 billon for fiscal years 2005 to 2010. Google challenged this tax audit, which led to a landmark decision rendered by the Administrative Court of Paris on 12 July 2017.

In order to establish whether a permanent establishment existed, it was necessary to check whether:

Google France was a dependent agent of Google Ireland, and
Google France had the authority to bind Google Ireland.

The Court first considered that Google France was a dependent agent of Google Ireland both:

from a legal point of view, given that these two entities are ultimately owned by Google Inc. (a US company), and
from an economic point of view, as Google France provides services exclusively to Google Ireland and does not bear any financial risk thanks to a guaranteed remuneration (cost plus).

The second element was more complex to study.

The tax authorities argued that, although the terms of the MSA explicitly deny Google France any authority to engage Google Ireland, Google France’s employees would have been "in effect" vested with the power to enter into contracts on behalf of Google Ireland, claiming that advertising contracts were "negotiated" and then "substantially concluded" by them.

The French tax authorities have raised elements showing that Google France was deeply involved in the sales process, such as reference in internal documents explaining the functions of Google France employees (eg developing the turnover or “the recruitment of new clients”) or references to sales functions in Google France job offers.

The Court held that, although these elements might tend to make the tasks of certain employees of Google France appear to go beyond the strict framework of the missions assigned to Google France under the MSA, these elements did not establish that these employees had the power to act on behalf of Google Ireland.

Indeed, the Court's analysis relied on the advertising service contract signed by Google Ireland with the final customers and emphasised the fact:

that these contracts were expressly concluded between the customer and Google Ireland
there was no evidence that the legal terms of these contracts had not been established by Google Ireland
that advertisements could not be placed online until Google Ireland’s definitive validation.

As a result of this decision, although Google France seems to be deeply involved in the sales process, it cannot lead to the existence of a permanent establishment of Google Ireland in France since Google France (or its employees) does not have the authority to bind Google Ireland who remains the ultimate decision maker with respect to the conclusion of contracts.

This being said, the situation may change in the future as a new definition of a permanent establishment has been introduced in the OECD tax treaty (and in the Multilateral Instrument (MLI)) pursuant to which the recognition of a permanent establishment will be established in the presence of a person who acts on behalf of an enterprise and, in doing so, habitually concludes contracts, or habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise (article 12(1) of the MLI).