Germany: 012. Tax Treaty - Independent Agent and Permanent Establishment

Last Updated: 25 April 1995
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In a judgement rendered on 14 September 1994 (DB 1995, 609), Germany's highest tax court has provided significant guidance as to the circumstances under which an independent agent can create a permanent establishment for its principal.

Under the OECD model treaty and most of Germany's tax treaties, an independent agent (unlike a dependent one) only constitutes a permanent establishment if it acts outside of the ordinary course of its business. Accordingly, enterprises of one contracting state can do business through independent agents in the other contracting state without being subject to tax liability in that state as long as the independent agent acts within the ordinary course of its business. Dependent agents, on the other hand, are far more likely to create permanent establishments.

The cited case has significantly clarified the meaning of action "in the ordinary course of one's business". It has not, however, contributed much to the understanding of how to distinguish independent agents from dependent agents.

The case involved a UK company (the Limited) and an affiliated German company (the GmbH) with the same ultimate parent. The Limited distributed industrial rubber products throughout Europe. The GmbH manufactured and sold similar products. The GmbH also acted as sales agent for the Limited, selling the Limited's products in the latter's name and for its account. The tax authorities claimed that the GmbH constituted a permanent establishment of the Limited with respect to this selling activity.

The Cologne Tax Court (EFG 1994, 138 - 7 July 1993) agreed that the GmbH was an independent agent, but held that the GmbH nevertheless constituted a permanent establishment for the Limited because the GmbH had not acted in the ordinary course of its business. The Tax Court based its ruling on a comparison of the activities of the GmbH as agent with its other business activities. Since the agency activities were secondary in importance and the predominant business of the GmbH was to sell products in its own name and for its own account, the Tax Court reasoned that the agency activity was outside of the ordinary course of the GmbH's business.

The Federal Tax Court reversed the lower court, holding that the question as to whether an agent is acting within the scope of its ordinary business was to be determined by comparison with the typical activity of agents of the sort involved and not by comparing the agent's activities as agent with its other business activities. The Court conceded that UK tax treaty stated that independent agents created no permanent establishment where they "are acting in the ordinary course of their business", as opposed to simply "in the ordinary course of business". The former wording might imply attention to the particularities of the business in question, whereas the latter might be seen as directing attention to what was customary in the trade in general.

The Court stated, however, that determining the ordinary course of each business with respect to its own specific situation would not yield convincing results. If such an interpretation were to be followed, what was "ordinary" would depend on the scope of the previous business of a particular agent. This would mean that practically any new activity would not be "ordinary". A manufacturing company would, for instance, create a permanent establishment with its first agent activity (acting outside the scope of its ordinary = previous business), but any additional agency activities later added on might not create a permanent establishment because, by virtue of the first agent activity, such activity would now be in ordinary course of its business.

For these reasons it appears that the question of whether an agent is acting within the ordinary course of its business is to be judged independently of the other business activities carried out by the agent. What is important is the extent and the manner in which the agency activities are carried out. If these are comparable with what is customary in the trade for other agents in the same line of business, then the agent is acting "in the ordinary course of its business".

The German Commercial Code codifies the basic rights and obligations of three different types of agents:

1. Commercial agent (Handelsvertreter - sections 84 - 92c HGB)
2. Commercial broker (Handelsmakler - sections 93 - 104 HGB)
3. Commission agent (KommissionSr - sections 383 - 406 HGB)

In structuring a relationship with an independent agent to avoid creation of a permanent establishment, it would appear advisable to adhere to one of the above three statutory "patterns" and above all to avoid mixing elements from different types of agency relationships. Furthermore, due regard should be given to what is customary in the particular line of business for an agent of the type selected.

As alluded to above, the case here discussed does not add much to what was already known on the issue of how to distinguish independent agents from dependent ones. The Court does make clear that neither the mere fact that agent and principal are members of the same corporate group nor the fact that the agent was required to respect the general instructions of its principal is sufficient to cause an agent to be dependent. The independence of the GmbH was clear in this case in light of its considerable business activity outside the scope of the agency relationship. The case thus leaves open whether a group company which acts exclusively as the agent of another group company may be "economically" dependent on its principal and thus a dependent agent.

The concept of a permanent establishment is a fundamental one for modern tax treaties. Typically, each contracting state surrenders its right to tax the profits of an enterprise of the other state unless such enterprise maintains a permanent establishment in its territory and the profits are attributable to this permanent establishment. There are, generally speaking, three ways by which an enterprise can create a permanent establishment in another country:

1. through a fixed place of business
2. through a dependent agent
3. through an independent agent

Disclaimer and Copyright
This article treats the subjects covered in condensed form. It is intended to provide a general guide to the subject matter and should not be relied on as a basis for business decisions. Specialist advice must be sought with respect to your individual circumstances. We in particular insist that the tax law and other sources on which the article is based be consulted in the original, whether or not such sources are named in the article. Please note as well that later versions of this article or other articles on related topics may have since appeared on this database or elsewhere and should also be searched for and consulted. While our articles are carefully reviewed, we can accept no responsibility in the event of any inaccuracy or omission. Any claims nevertheless raised on the basis of this article are subject to German substantive law and, to the extent permissible thereunder, to the exclusive jurisdiction of the courts in Frankfurt am Main, Germany. This article is the intellectual property of KPMG Deutsche Treuhand-Gesellschaft AG (KPMG Germany). Distribution to third persons is prohibited without our express written consent in advance.

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