The Paris Court of Appeal affirmed that Google Ireland does not have a French permanent establishment in a high-profile tax controversy over a double Irish arrangement. But with independent criminal proceedings for tax evasion looming, Google agreed to a EUR 1 billion settlement under a non-prosecution agreement.
While the French tax authorities failed to characterize a French permanent establishment of Google Ireland, Google’s short-lived victory, the implementation of the OECD’s Multilateral Convention, and new prosecuting practices make the current state of play for the French Government and digital multinational companies uncertain.
On 25 April 2019, the Paris Court of Appeal dismissed the French Minister of Finance’s appeals of five judgments rendered on 12 July 2017 by the Paris Tax Court in a widely publicized tax controversy involving Google Ireland and Google France.
The controversy began several years ago with the search and seizure of Google France’s premises. This was followed by a tax audit of Google Ireland, with administrative assistance from Ireland, the United States and the Netherlands. Following the tax audit, the French tax authorities concluded that Google Ireland conducted an advertising sales business through a French permanent establishment. The French tax authorities issued corporate tax, VAT and business tax assessments on income attributed to Google Ireland’s French permanent establishment. A portion of the royalties paid by Google Ireland to Google Netherlands Holdings was also attributed to the French permanent establishment and was therefore subject to French withholding taxes. The total amount of the tax adjustments exceeded EUR 1.1 billion.
Grounds for the Tax Assessments
In addition to running a search engine, Google offers an online advertising service known as AdWords, allowing advertisers to place promotions on search results or with Google partners, usually on a pay-per-click or cost-per-acquisition basis. Placements are made in accordance with keywords selected by advertisers, subject to automated bidding and capping mechanisms. All are under the responsibility of Google Ireland for the European market.
AdWords is offered either through an online sales organisation arrangement, where advertisers manage their online advertising campaigns themselves, or through a direct sales organisation (DSO) arrangement, where advertisers also receive consulting services and commercial assistance from Google France. Google France receives compensation for its involvement with DSO advertisers on a cost plus 8% basis in accordance with a marketing and services agreement with Google Ireland.
According to the French tax authorities, Google France was involved in negotiations with DSO advertisers regarding orders intake, after-sale services, client recruitment, business development and key account management, as evidenced by internal documents seized on the premises, employee testimonials and the presence of an in-house lawyer dedicated to drafting and negotiating commercial agreements. While not formally empowered to do so, Google France was regarded as actually concluding online advertising service agreements on behalf of Google Ireland. Therefore, Google France should be considered as the dependent agent of Google Ireland under Article 2(9)(c) of the France-Ireland tax treaty. Google Ireland could alternatively be viewed as having a fixed place of business in France through the premises of Google France.
The first point of contention was whether Google France could be viewed as a dependent agent of Google Ireland, as Google Ireland does not have formal control over Google France. However, because Google France (1) is a sister company of Google Ireland (both of which are held by Google Inc.), (2) does not bear any financial risk (since it is compensated on a cost plus basis) and (3) derives all of its revenue under the marketing and sales agreement with Google Ireland, the Court ruled that Google France was both legally and economically dependent on Google Ireland and could, therefore, be viewed as its dependent agent.
The second and more critical point of contention was whether Google France could be viewed as the French permanent establishment of Google Ireland under Article 2(9)(c) of the France-Ireland tax treaty. (This provision is consistent with the OECD Model Tax Convention.) According to the tax treaty, a dependent agent constitutes the permanent establishment of the principal if that dependent agent has the authority to conclude contracts in the name of the principal and habitually exercises that authority.
As stated by the Court, while Google France’s actions are critical to the conclusion of online advertising service agreements with DSO advertisers, none of such actions may result in Google France being regarded as de facto exercising the authority to conclude contracts in the name of Google Ireland, which ultimately makes the decision whether to enter into such agreements. Additionally, the effective placement of the advertisements as well as their pricing results from a prior validation by, and subsequent bidding process conducted under the responsibility of, Google Ireland. Consequently, while Google France was a dependent agent of Google Ireland, it could not be viewed as exercising the authority to conclude contracts in the name of Google Ireland and, therefore, as its French permanent establishment.
The third and final point of contention was whether Google France’s premises could be viewed as a fixed place of business of Google Ireland. According to the Court, the premises were only used by Google France for the services provided to Google Ireland in accordance with the marketing and services agreement. Consequently, Google Ireland could not be viewed as operating a business out of Google France’s premises and, therefore, as having a fixed place of business in France.
Based on the above, the Paris Court of Appeal affirmed the cancellation of the tax assessments ordered by the Paris Tax Court.
The Permanent Establishment Conundrum
Subsidiaries are legally distinct from foreign related companies and in general cannot be considered as their permanent establishments. However, case law has found that subsidiaries could qualify under certain conditions as the permanent establishment of a foreign related company. This bifurcation applies primarily in cases where a French subsidiary is a dependent agent of the foreign related company, requiring a legal and economic dependence between both companies. A permanent establishment may thereafter be so characterised only if the dependent agent has the authority to conclude (or actually concludes) contracts in the name of the foreign related company, and only if such contracts relate to the foreign related company’s operations. A French subsidiary may also be considered as the permanent establishment of a foreign related company if that foreign related company operates a business through its French subsidiary’s premises and thus has a fixed place of business in France. However, French courts have been restrictive in their approach to this matter. In all cases where a French subsidiary was recognised as the permanent establishment of a foreign related company, the French subsidiary carried out virtually all of the business of the foreign related company, which itself had little or no substance.
In the Google cases, Google France was found to be a dependent agent of Google Ireland but did not have the authority to conclude contracts in the name of Google Ireland, let alone in relation to Google Ireland’s operations, thereby precluding the qualification as a French permanent establishment of Google Ireland.
The difficulty for tax authorities to identify permanent establishments in similar contexts—such as limited risk distributor, commissionaire or marketing office arrangements—has been a major topic of the Organisation for Economic Co-operation and Development’s Base Erosion and Profit Sharing (BEPS) Actions.
The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS aims at closing this legal gap by simultaneously amending the permanent establishment definition of multiple tax treaties through a cross-election mechanism. Under Article 12(1) of the Multilateral Convention, a dependent agent will be considered as the permanent establishment of its principal if the agent habitually concludes contracts on behalf of the principal or plays the primary role leading to the conclusion of contracts routinely concluded without any material modification by the principal.
The Multilateral Convention entered into force on 1 July 2018, but its effective date on covered tax treaties may be postponed depending upon the ratification process of each contracting state. In any event, the new rules will only apply prospectively.
Tax Authorities and the National Prosecutor Double-Team Google to Force a Settlement
Under French law, tax proceedings and criminal proceedings are fully independent, up to the point that in certain (controversial) cases, a taxpayer was found guilty of tax evasion even though a tax court had already discharged the taxpayer from any tax adjustments. In other words, a tax court could rule that no tax was due by the taxpayer, but a criminal court could subsequently rule to the contrary, subjecting the taxpayer to conviction for tax evasion under identical circumstances.
Although Google Ireland’s position with the French tax authorities seemed strengthened by favourable decisions both from the trial court and the appeals court, Google Ireland still faced criminal prosecution for tax evasion. In addition, the French Minister of Finance appealed the Paris Court of Appeal decisions to the French Supreme Tax Court (Conseil d’État).
Google therefore relented and agreed to a non-prosecution agreement whereby Google Ireland paid a fine of EUR 500 million for the period 2011–2016 and tax adjustments of EUR 465 million for 2011–2018. The French Minister of Finance withdrew the appeal to the French Supreme Tax Court, and the national prosecutor declined to prosecute.
This turn of events, in what initially seemed like a losing battle, could mark the beginning of a new strategy for the French tax authorities. Faced with multinational companies, the authorities’ objective is no longer to win in court but to force the taxpayer into settlement of a perhaps unmeritorious case through relentless investigations and independent proceedings, creating an unacceptable level of uncertainty. Under certain circumstances, a tax court’s decision discharging a taxpayer from all tax adjustments may be contrasted to a criminal court to avoid a conviction otherwise based upon the same tax adjustments.
If confronted with the “Google strategy”, taxpayers should first carefully analyse their tax situation and assess their chances in tax court. Then they can determine whether to consider a settlement to avoid prosecution.