Peter Barnes Comments on "Permanent Establishment" in Formula One Cases

Tax Notes

Formula One is [] a wildly lucrative franchise with licensing restrictions that make McDonald’s look lackadaisical. These extensive licensing restrictions caused the Indian Supreme Court to affirm a lower court decision that Formula One World Championship Ltd. had a permanent establishment in India (Formula One World Championship Ltd. v. Commissioner of Income-tax, (IT)-3, Delhi, [2017] 80 347 (SC), Apr. 24, 2017). More PE cases are heading to the Indian courts. (Prior coverage: Tax Notes Int’l, May 1, 2017, p. 401.)

Formula One and other PE-related matters, presented from the vantage point of a corporate tax manager, were the subject of a July 18 International Tax Institute luncheon speech in New York by Peter A. Barnes, a former GE senior international tax counsel who is currently teaching at Duke University Law School and is of counsel at Caplin & Drysdale. Barnes believes that the latest PE changes, and the position of some countries, are unprincipled. But inside a multinational, practicality and predictability are what matters. The new changes are also unpredictable.

Rehashing the old joke that a company has a PE in India when an employee steps off the plane and puts his briefcase on the ground, Barnes admitted that the country with the most aggressive approach to PE is the United States — at the state (economic nexus) and federal (effectively connected income) levels (section 871 et seq.). He bemoaned the worldwide trend toward taxation of local sales.

Formula One

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An Indian company, Jaypee Sports International Ltd. (JP), agreed to pay $40 million to enter into a five-year renewable race promotion contract with FOWC, giving JP the right to host, stage, and promote the Indian Grand Prix. JP agreed to pay $1 million to enter an artwork licensing agreement for FOWC trademarks and intellectual property. Simultaneous back-to-back agreements saw JP surrender rights it had just licensed from FOWC back to the latter’s affiliates. So JP contracted all rights to Indian television feed to FOAM, track media rights to another FOWC affiliate, and paddock rights to yet another FOWC affiliate.

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So what are taxpayers excited about? “It’s just a restrictive license,” said Barnes. The taxpayer argued that as a mere rights holder, it acted as a consultant and adviser, and that the contract with JP was not a sham.

“Every franchisor which has restrictions — do they now have a fixed place of business?” Barnes asked rhetorically. “Really? Are we going to be in a world where a license is a PE?” The Indian courts held that the entire contract price was income of the PE, even if not all of it would be subject to withholding. “It’s a pretty dramatic comment. I’m not sure what the limits would be,” said Barnes.

Protective Returns

File a protective return if there is a risk that there is a PE and then argue about the thing’s income. It’s the GE way. Barnes noted that corporate tax managers hate that advice. Managers and advisers are conventionally drilled in mitigating PE risk by counting employees’ days in a country, using secondments, and calibrating supply chain relationships.

But often a branch in the country is necessary for seemingly mundane issues like keeping valuable employees on the regional parent’s payroll, Barnes explained. And by expressly acknowledging the existence of a PE, the taxpayer makes some serious problems go away. That is, the taxpayer removes the threat of assertions of penalties for failure to file returns and taxation of gross income. The taxpayer would also be spared arguments with financial accountants about booking a deferred tax liability for a potential PE.

Yes, gross income. Barnes cited the Google dependent agent PE case in France for the proposition that tax authorities often start with gross income when the taxpayer hasn’t filed a return for a PE. (Prior coverage: Tax Notes Int’l, July 17, 2017, p. 207.) Also, taxpayers should make sure that the acknowledged PE has its own set of books and records (preferably in local currency and local language) to sustain arguments about what income should be attributable to the PE. “The atmospherics changed even if the law didn’t,” he said. “We’re going to have to work through the hate.”

Barnes reiterated the advice of his former GE colleague Michele Lenotti that acknowledging a PE and filing a return moves the argument to income attribution to the PE and the tax liability on that income. Lenotti’s bottom line for tax managers: Acknowledge that you have a PE and then fight about the income that would be attributable to it. Only by acknowledging the existence of a PE does the taxpayer move the fight to its ground. (Prior analysis: Tax Notes Int’l, Mar. 28, 2016, p. 1071.)

But when companies file protective PE returns showing little income and a lot of expenses, a mismatch of expectations could occur, according to Barnes. Governments expect that they will be able to claw back a lot of income once a PE is acknowledged, and country-by-country disclosures may feed that impression. In India, payment of market compensation to a dependent agent does not settle the question of how much income should be attributed to the PE (SET Satellite (Singapore) Pte Ltd. v. DIT (106 ITD 175)). (Prior analysis: Tax Notes Int’l, Aug. 11 2008, p. 517.)

“There’s too much scope for countries to say ‘Aha!’” said Barnes, citing with disapproval an Indian case in which compensation for manufacturing and research and development was attributed to the fixed place PE of the British parent of a cost-plus distributor of aircraft engines (Rolls Royce Plc. v. Deputy Director of Income-Tax, 19 SOT 42). (Prior coverage: Tax Notes Int’l, Dec. 10, 2007, p. 1015.) Moreover, taxpayers should be globally consistent in their stories. (Prior analysis: Tax Notes Int’l, Jan. 5, 2015, p. 54.)

For the full article, please visit Tax Notes’ website (subscription required).

Excerpt taken from the article “News Analysis: Permanent Establishment on Wheels” by Lee A. Sheppard for Tax Notes.


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