The role of the ‘Rationality Test’ in attributing supplies of service to fixed establishments – A critical approach to Case C-605/12 (Welmory)

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Notes

1 The abbreviation ‘CJEU’ is used to refer to both the Court of Justice of the European Union (as it has been since the entry into force of the Treaty of Lisbon on 1 December 2009) and the Court of Justice of the European Communities (as it previously was).

2 Recital 14 in the preambles to the Regulation. 

3 The VAT Committee had unanimously confirmed that only if an establishment has a minimum size of both human and technical resources permanently present in a Member State may it be regarded as a fixed establishment for VAT purposes (VAT Committee, Working Paper No 619 of 11 May 2007, 2). It has been observed that the definition laid down in the Regulation leaves the individual Member States room for their own interpretation on what should be meant by fixed establishment, in particular ‘as to the question of whether or not a structure, in terms of human and technical resources, to enable it to receive and use the services supplied to it for its own needs, or to provide the services which it supplies’ (M Kern, ‘Fixed and Permanent Establishments in VAT/GST and Direct Taxation’, in S Pfeiffer, M Ursprung-Steindl (eds), Global Trends in VAT/GST and Direct Taxes (Wien, Linde, 2015), 221.

4 See Case C-605/12 Welmory [2014] ECLI:EU:C:2014:2298, para 54.

5 Recitals 18 in the preambles to the Regulation.

6 See R de la Feria, ‘Permanent Establishments in Indirect Taxation’ in IBFD (ed), Permanent Establishments (Amsterdam, IBFD, 2016).

7 EU tax legislation provides that any decision is taken by unanimity voting of each Member State so that it becomes more and more difficult to have any new legislation approved.

8 See Case 168/84 Berkholz [1985] ECLI:EU:C:1985:299.

9 See Berkholz (n 8) para 17: ‘According to Article 9(1), the place where the supplier has established his business is a primary point of reference inasmuch as regard is to be had to another establishment from which the services are supplied only if the reference to the place where the supplier has established his business does not lead to a rational result for tax purposes or creates a conflict with another Member State’.

10 See C-190/95 ARO Lease [1997] ECLI:EU:C:1997:374 and C-390/96 Lease Plan [1998] ECLI:EU:C:1998:206 where fixed establishments were found not to exist.

11 See Case C-260/95 DFDS [1997] ECLI:EU:C:1997:77 (para 22) the result would not be rational if it takes no account of the actual place of consumption (in the decision ‘where the tours are marketed which should be considered the place were, whatever the customer's destination, the national authorities have good reason to take into consideration as the most appropriate point of reference’). On this point the decision follows what is stated by AG La Pergola (para 32) which took into consideration the ‘actual economic situation’. See also Point 32 of the conclusions of AG Mancini in Berkholz (n 8): ‘That is the basic criterion: the VAT system must be applied in a manner as far as possible in harmony with the actual economic situation. I do not consider it logical for the subsidiary criterion, when the possibility of applying it is assessed, to be automatically treated as being subordinate to that of the place where the supplier has established his business’. The argument has also been developed in the conclusions of AG Maduro in Case C-452/03 RAL (Channel Islands) [2005] ECLI:EU:C:2005:289, para 44: ‘I am of the opinion that here it is necessary to undertake an analysis that is especially responsive to the factual economic and commercial reality of the case’ so that one may argue that the Rationality Test should be construed on the basis of a substantive approach.

12 It has been observed that according to DFDS, in an agency relationship, in the event that a supply of services escapes VAT in both States, the fact that a business activity is carried out by a non-resident through a separate legal entity established in another Member State is not in itself sufficient to conclude that the controlled company cannot be a fixed establishment of the controlling company. If the supply actually escapes VAT in both States, one would need to consider the activity actually rendered by the subsidiary. If such subsidiary merely acts as an auxiliary organ of the latter and, as a consequence, it loses its distinction from the controlling company, the non-resident may have a minimum size of human and technical resources that may characterize a fixed establishment (see A Parolini, ‘Multinational Companies and VAT: A First Reaction to the Philip Morris Italian Supreme Court decision’ (2003) 7.1.5. The EC Tax Journal).

13 DFDS (n 11) para 23.

14 Conclusions of AG Maduro in RAL (Channel Islands) (n 11) para 60.

15 Conclusions of AG Jacobs in Case, C-438/01 Design Concept [2003] ECLI:EU:C:2003:325 (para 30).

16 Aro Lease (n 10) para 26. The same argument has been mentioned by AG Kokott in her opinion to Welmory (n 6) para 29: ‘for the service provider there must be legal certainty as to the existence of a fixed establishment of the recipient of his service. This is because, depending on the existence of such a fixed establishment within the territory of the country, the service provider will or will not be liable for tax’.

17 DFDS (n 11) is the only case in the jurisprudence of the CJEU where an examination of the rationality of the result for VAT purposes was undertaken. In other cases, that criterion did not have to be applied because the Court did not recognize the existence of a fixed establishment.

18 Conclusions of AG Maduro in RAL (Channel Islands) (n 11) para 62: ‘the Court considered that to treat the services supplied by a company through undertakings operating on its behalf in one country as being supplied from a different country where the tour operator had established its business would not be rational for tax purposes. In effect ‘systematic reliance on the place where the supplier has established his business could in fact lead to distortions of competition, in that it might encourage undertakings trading in one Member State to establish their businesses, in order to avoid taxation, in another Member State which has availed itself of the possibility of maintaining the VAT exemption for the services in question’ (see case DFDS, para 23)’.

19 According to AG Maduro ‘if the place where the suppliers had decided to establish their place of business had in those cases been located outside the territory of the Community, the application of that connecting factor would certainly have raised many doubts’ (see para 62 of the conclusions in RAL (Channel Islands) (n 11)).

20 This was indeed the result in DFDS (n 11). In this context, it has been observed that ‘what at first seemed to be a reluctance by the CJEU [in Berkholz] to refer to secondary establishments . . . was merely a means to avoid businesses escaping the Community's tax jurisdiction by creating national establishments outside Community territory; in the final analysis . . . rational results for tax purposes count, if the result is positive taxation rather than exemption’ (B Terra and J Kajus, ‘A Guide to the European VAT Directives’ (Volume 1, 2014) p 701).

21 The difference in the construction of the Rationality Test from the DFDS case to the Opinion of AG Maduro has been observed also by Rita de la Feria (n 6), where the author emphasizes that in RAL (Channel Islands) the concept of rational result for tax purposes ‘was extended from a criterion to choose between place of business or place of fixed establishment, to a criterion to choose between general and specific place of supply rules’ (see also R de la Feria, ‘Game Over for Aggressive VAT Planning?: RAL v Commissioner of Customs Excise’ (2005) 4 British Tax Review 394–401).

22 For an extensive analysis of the case see B Terra, ‘Internet and the Concept of “Fixed Establishment” of the Recipient of a Supply of Services: Case C-605/12 (Welmory)’ (2014) 3 (3) World Journal of VAT/GST Law 210–218. It has been noted that the decision in Welmory was waited as the Court had the chance to endorse the existence of virtual fixed establishment (that is narrow to the concept of agency permanent establishment laid down by the OECD Commentary on the Model Tax Convention) in the VAT field. However, by referring the case to the national court, the CJEU failed to explain under which circumstances a virtual fixed establishment can be deemed to exist (see A Bal, ‘Secondary Establishments in EU VAT and Treaty Law’ (2015) European Taxation 143–148; de la Feria (n 6)). It is worth noting that the uncertainty surrounding the concept of fixed establishment and more in particular of rational result already implied national practices and courts to find their own way to determine when the place where the customer has established its business led to a non-rational result. On 7 March 2002, the Italian Court of Cassation decided a case (decision no 3368/02, so-called Philip Morris case) regarding the existence in Italy of a German company for VAT purposes. The Court of Cassation leveraged on the principle laid down by Article 5 of the OECD Commentary and on the principles enshrined in DFDS in order to establish under which condition a subsidiary could be considered a fixed establishment of its parent company. Indeed, the Court stated that in DFDS the CJEU already considered a subsidiary, acting as an agent, to be a fixed establishment of the parent company. In this respect, the concept of agency permanent establishment for income tax purposes could be construed as a precondition to consider that agent a fixed establishment for VAT purposes provided that the dependent agent had human and technical resources for providing (rectius receiving) a supply of services. Under those circumstances, the condition of human and technical presence could have been satisfied even if the non-resident parent company did not have any effective presence on the Italian territory which could be ascribed to the latter. If one looks to Welmory, the fact that the CJEU did not expressly hold that a subsidiary could not be characterized as a fixed establishment of foreign parent company leaves ground to an interpretation similar to the one enshrined by the Italian Court of Cassation in Phillip Morris (for an extensive commentary on the decision see M Iavagnilio, ‘Concept of Permanent and Fixed Establishment under Italian Law—The Philip Morris Case’ (2002) International VAT Monitor 470–475; Parolini (n 12)).

23 See para 53. At para 54, The Court also states that the test established in the context of Article 9 of the Sixth Directive is ‘also valid in relation to Article 44 of the VAT Directive’.

24 On the assumption that input tax would be fully deductible in the hands of the Cypriot company. By contrast, if the Cypriot company were engaged in exempt activity, non-deductible VAT would have arisen in Cyprus thereby generating a loss of VAT resources in Poland.

25 If so, one might have expected the Court to rule that there was no ground to maintain that a fixed establishment of the Cypriot company existed in Poland as the place where a taxable person established its business is, according to settled case law of the CJEU, the primary point of reference for determining the place of supply of services, which may be overridden only if it does not lead to a rational result or creates a conflict with another Member State. Nevertheless, the Court ruled that it was up to the national court to ascertain whether in the case at stake the Cypriot company had the necessary human and technical resources in Poland for it to be able to receive services supplied by the Polish company and to use them for its own needs (see para 62 of Welmory).

26 That seems to fit more the interpretation of AG Maduro in RAL (Channel Islands) (n 11) than the one laid down in the CJEU early judgments.

27 This can be inferred from the conclusions of AG Kokott in Welmory (n 4) para 60. It is worth noting that the CJEU did not develop this issue, stating that the subject matter of the question referred for a preliminary ruling was related essentially to the place of taxation of services—hence on the interpretation of Article 44 of the VAT Directive—and not to the determination of the taxable amount of the goods sold by auction by the Polish company (Welmory (n 4) para 31).

28 On this issue see also Case C-272/13 Equoland [2014] ECLI:EU:C:2014:2091.

29 Conclusions of AG La Pergola in DFDS (n 11) para 28.

30 Case C-111/14 GST-Sarviz AG [2015] ECLI:EU:C:2015:267. It is worth noting that the case assumes that a fixed establishment is intervening in a supply of services within the meaning of Article 192a of the VAT Directive and Article 53 of the Regulation. GST was a German entity that rendered certain services to its Bulgarian related party. Considering that the supplier was not established for VAT purposes in Bulgaria, the recipient accounted for the VAT due on the supplies under the reverse charge mechanism. The tax authorities, however, took the view that the supplier had a fixed establishment in Bulgaria and that the supplies in question were rendered through this establishment. As a result, the authorities assessed VAT liabilities and penalty interests to the German entity for the services rendered to its Bulgarian related party. Since the VAT on the supplies was assessed with a notice of tax deficiency, the supplier was not able, under the Bulgarian VAT rules, to adjust the initial invoices and pass on the amount of VAT assessed by the tax authorities to the recipient. Nevertheless, the recipient claimed the VAT amount for refund directly from the tax office. This claim for reimbursement of the recipient was rejected by the tax authorities and brought to the Bulgarian Supreme Court, which finally referred the case to the CJEU.

31 If one looks to Case C-419/14 WebMindLicenses [2015] ECLI:EU:C:2015:832, it might be possible to maintain that double taxation could be allowed only in case of abuse of law.