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Trudy Perié
Loyens & Loeff, Amsterdam
trudy.perie@loyensloeff.com

Joost Pammler
Loyens & Loeff, Amsterdam
joost.pammler@loyensloeff.com

 

Introduction

The concept of a fixed establishment for VAT purposes is ever-evolving. Perhaps also driven by increased attention in the field of direct taxation and the Base Erosion and Profit Shifting (BEPS) Project, the (non-)existence of a permanent establishment seems to be leading to more discussions with tax authorities all over Europe. The fixed establishment issue in the European Union is particularly relevant for the taxation of business-to-business (B2B) cross-border services. Adding to the discussions is the case law of the Court of Justice of the European Union (CJEU), often bringing about more uncertainty than clarity for companies that have a presence in EU Member States. In its latest judgement of 7 May 2020, Dong Yang (C-547/18), the CJEU ruled on the question of whether a subsidiary in the EU may constitute a fixed establishment of a non-EU parent company. In this article, we will discuss the main aspects of the concept and the ruling of the CJEU in this case, as well as the practical implications.

Background

Whether a fixed establishment exists can be relevant for the recovery of EU VAT, for liability for VAT and compliance purposes. However, it is mainly of importance in the case of B2B cross-border services. As a general EU rule, services rendered to entrepreneurs are deemed to be subject to VAT in the country where the recipient is established or has a fixed establishment to which the service is rendered. The recipient – instead of the non-resident supplier – should account for VAT under the reverse charge mechanism. A few exceptions apply to this general rule, for example, with respect to services connected to immovable property. The supply of services or cost allocations between a head office and its fixed establishment are, from an EU perspective, generally out of scope for VAT purposes as they occur within the same legal entity (according to the CJEU's case FCE Bank, C-210/04).

According to EU legislation, within this framework a fixed establishment is present if it has a sufficient degree of permanence and a suitable structure in terms of human and technical resources to enable it to receive services and use those services for its own needs.

The CJEU has dealt with the concept of a fixed establishment on several occasions. In the DFDS case (C-260/95), which dates from 1997, it ruled that a subsidiary may qualify as a fixed establishment if it merely acts as an auxiliary organ of the parent on the basis of contractual agreements. Since then, the following question has arisen: was this an incident or had the CJEU meant to say that a subsidiary in itself should be an indication that a fixed establishment is present?

Dong Yang case

A Polish company, Dong Yang, provided services to a Korean customer, LG Korea, that consisted of assembling printed circuit boards (PCBs). The materials and components needed for the manufacturing of the PCBs were owned by LG Korea, but were physically delivered to Dong Yang by LG Poland, a Polish subsidiary of LG Korea. LG Poland installed the PCBs into liquid-crystal display (LCD)-modules of LG Korea that were later sold to EU customers.

LG Korea assured Dong Yang that it did not have a fixed establishment in Poland as it did not locally possess employees, property or technical resources. Assuming LG Korea should be considered the recipient of its assembly services and thus the place of taxation would be Korea, Dong Yang raised invoices to LG Korea without charging Polish VAT. The Polish tax authorities subsequently argued that LG Poland, even though LG Poland was a subsidiary of LG Korea and an independent legal entity, should be considered a fixed establishment of LG Korea. The Polish tax authorities found that Dong Yang should not have solely relied on the statement of LG Korea (no fixed establishment), but had to further examine whether LG Poland was a fixed establishment that had the benefit of the assembling services. On that basis, the Polish tax authorities concluded that Dong Yang should have charged Polish VAT to LG Korea (domestic supply). The CJEU was asked whether: (1) having LG Poland as a subsidiary means, by definition, that LG Korea has a fixed establishment in Poland; and (2) if not, whether Dong Yang is required to assess the contractual relationship between the LG-entities in this context.

According to the CJEU, the mere holding of an EU subsidiary does not automatically indicate the existence of a fixed establishment of the parent company. It can, however, not be ruled out that a subsidiary constitutes a fixed establishment. It should therefore be assessed whether the subsidiary has the characteristics of a fixed establishment and fulfils the standard conditions (Article 11 of the Implementing Regulation VAT Directive (VD)). The legal form is not decisive; economic and commercial reality should also be considered. The CJEU furthermore ruled that identification obligations do not reach so far that Dong Yang is required to investigate extensively the relations between LG Korea and its local subsidiary, LG Poland.

Analysis

The CJEU, not surprisingly, ruled that having a subsidiary does not automatically imply that the non-EU parent company has a permanent establishment. Regrettably, however, the CJEU stated that, in principle, it is possible that a subsidiary constitutes a fixed establishment. Advocate General Kokott advised the CJEU to rule that a subsidiary should by default be considered an independent taxable person unless there is abusive practice that leads to a VAT benefit. Unfortunately, the CJEU does not provide any guidelines regarding under which factual circumstances a subsidiary should qualify as a fixed establishment. This leaves non-EU companies with EU subsidiaries with uncertainty, as well as their suppliers. The same goes for EU companies with offices and/or subsidiaries in other EU Member States, in particular in the case in which their activities are VAT exempt and/or have a different VAT treatment in the EU Member States involved.

The standard conditions still apply in that the fixed establishment is characterised by having a sufficient degree of permanence and a suitable structure in terms of human and technical resources to enable it to procure and/or supply services. These conditions should, according to the CJEU, be assessed in the light of economic and commercial reality. The CJEU repeated (with reference to its previous judgment, Welmory, C-605/12­)that the primary point of reference for determining the place of taxation of services remains the place where the customer has established its business, and that the fixed establishment is an exception to this rule. Thus, it should ensure the proper functioning of the VAT law, avoiding double taxation and non-taxation. Even though this was not explicitly mentioned by the CJEU in the Dong Yang case, we feel that a fixed establishment should still only be recognised if the main place of establishment does not lead to a fiscal rational result or to conflict between EU Member States.

Impact in practice

As a starting point, it is always recommended to check whether a fixed establishment is present, not only for suppliers but also for customers. The supplier should know whether it has to charge domestic VAT to a local fixed establishment of its customer abroad. Also, if the supplier has a fixed establishment in the country of the customer (eg, for projects requiring local presence), the supplier should generally register and charge local VAT on its services. The customer, on the other hand, might be liable to account for VAT (on the basis of the reverse-charge mechanism) if its fixed establishment is using services procured from a foreign supplier.

Although it remains to be seen, we expect the practical impact of the Dong Yang case to be limited to only very specific situations. First and foremost, the customer is often entitled to fully deduct input VAT. In such a case, in theory, the tax authorities should not have any interest in debating the possibility of a fixed establishment. That being said, it is still advisable to observe extra caution where services are performed for a non-EU customer that has an EU address or EU subsidiary (as in the Dong Yang case). Furthermore, in the case of an EU customer with an address or subsidiary in another EU Member State, it may occur that different VAT treatments apply in those EU Member States involved. Also, if the customer does not have the right to fully recover VAT, there may be a conflict between EU Member States as to where VAT should be levied. In such circumstances, it is more likely that tax authorities may argue that a fixed establishment exists to secure the right to levy VAT.

Final remarks

The Dong Yang case confirms that the supplier should always investigate whether a fixed establishment is present; also if it concerns a subsidiary of its customer. The supplier is, however, not obliged to extensively examine the contractual relations between the customer and its subsidiaries. Although this alleviates the supplier of a heavy administrative burden, it is important to remain cautious when supplying services to foreign customers with a local presence in (different) EU Member States. In view of potential discussions with the tax authorities, suppliers are advised to properly identify customers and investigate whether they possess a fixed establishment if there are indications to that extent.

As we keep monitoring developments, the final verdict on the fixed establishment has not been delivered. The CJEU will be ruling on a pending case (Titanium v Austria, C-931/19) on the question of whether a fixed establishment could be recognised through immovable property without the involvement of the service provider's own employees. That decision may very well have a significant practical impact.

 

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