Article by Luís Aires
Indirect Tax Advisor
Author/Researcher on VAT Policy/Case Law and Indirect Tax Technology
Permanent establishment for VAT and its nexus with BEPS – Part 1
This is the 1st part of two articles regarding the issue of the permanent establishment in the digital transformation era and its nexus with the BEPS Project. In this article we will adress the notion of a permanent establishment, the ECJ case-law on the matter and the opinion of the VAT Committee. The second part we will get into the BEPS risks and broader challenges for VAT/GST, specifically the ones that arise from highly digitalised businesses structuring their affairs to pay little or no VAT on remotely delivered services and intangibles and the collection of VAT on cross-border supplies of goods, services and intangibles from online sales, particularly cross-border B2C sales.
Definition of permanent establishment
The notion of “permanent establishment” (PE) is one of the most important concepts in the EU’s VAT system. The interpretation of this term may be decisive in establishing the place of supply of given services as well as the possibility of applying the reverse charge mechanism.
The legal definition of fixed establishment was not created until 1 July 2011. Under Council Implementing Regulation No 282/2011, article 11.1, according to which for the application of the VAT Directive art.44 a ‘permanent establishment’ shall be any establishment, other than the place of establishment of a business, characterised by a sufficient degree of permanence and a suitable structure in terms of human and technical resources to enable it to receive and use services supplied to it for its own needs. For the supplied services, art.11.2 includes a similar approach.
In light of this definition, the following aspects determine whether there is a PE:
- The time over which the establishment is maintained
- Technical resources
- Human resources
- Ability to receive and use services.
The contribution of ECJ case-law
The judgment of 4-7-1985, Berkholz, C-168/84, is the first one. The ECJ concluded that an installation for carrying on a commercial activity, such as the operation of gaming machines on board a ship sailing on the high seas outside the national territory, may be regarded as a PE only if the establishment entails the permanent presence of both the human and technical resources necessary for the provision of those services and it is not appropriate to deem those services to have been provided at the place where the supplier has established his business.
This is the first case in which the ECJ is close to the concept of PE, which is not defined by the Directive, and does so by stating the following requirements:
a) The PE must have a «certain consistency». It seems that the ECJ wants to exclude from this consideration certain small structures, requiring that in order to actually exist PE, the corresponding means are relatively important and linked to the concerned Member State with a certain aim of permanence.
b) The PE must have the human and technical resources necessary to carry out the operations. If only material means of production are available, and it cannot be argued that slot machines were, it is not possible to appreciate the existence of such a PE.
c) The means with which the PE has the capacity to provide the services to be located. A functional requirement in the configuration of the PE is added to the above, in such a way that only if the means attributed to the PE can perform the operations in each case, then the PE can be considered as such.
Until recently, these criteria were deemed fulfilled only in the case of foreign entities with their own infrastructure and personnel; only foreign companies possessing technical resources (such as machinery and warehousing) and staff hired under employment contracts were regarded as taxpayers with a fixed establishment in a given country.
The judgment of 16-10-2014, C-605/12, Welmory, again affects the concept of PE, although in the light of the amendments introduced on the occasion of the entry into force of Directive 2008/8. The case related to an online auction platform.
Focusing the question on the determination of a PE, the first issue that arose was whether the previous case-law remained in force, taking into account the modifications carried out in this matter by art.44 of the VAT Directive. The ECJ expressly declared the continuity of the case-law on the matter.
On the concept of the PE itself, and by reference to the recipient of the supplies, the CJEU referred to the judgment of 28-6-2007, Planzer Luxembourg, C-73/06, in which it stated that the wording of art.11 of the Implementing Regulation is directly based, stating that: «a fixed establishment must be characterised by a sufficient degree of permanence and a suitable structure in terms of human and technical resources to enable it to receive and use the services supplied to it for its own needs» (par.58).
In the specific case, the ECJ referred to the structure of means used by the entity to their capacity to receive the corresponding services. This aptitude must refer to the economic activity carried out by the entity that receives the services, in this case consisting of the management of the auction system and the issuance of the «bids».
With the understanding that the aforementioned means were located outside the Polish territory, which corresponds to be verified by the national jurisdiction, the existence of a PE for these purposes in the aforementioned territory was ruled out.
Considerations regarding the analysis of the structure as a whole or the location of the final recipients of the operations were discarded, the first of them perhaps because the analysis of the structure from the perspective of the anti-abuse clauses had not been proposed and the second as irrelevant.
It was finally concluded that in order for a taxpayer to be considered to have a PE for the purposes of the VAT Directive (version given by Directive 2008/8) art.44, it would need to hold at least one structure characterised by a sufficient degree of permanence, suitable, in terms of human and technical means, to enable it to receive the services and use them for the purposes of its economic activity. The ECJ case-law on the matter is reiterated. The existence of a PE to the effect of VAT requires an adequate degree of permanence in the concerned jurisdiction, the conjunction of human and material resources and the capability to provide or to receive the disputed supplies. While not explicitly stated, the judgment implies that the resources need not belong to the company in order to create a fixed establishment of that company (i.e. a fixed establishment may be created by a third party’s resources). However, the foreign entity should have control over the resources.
So far the definition of what a PE is, but it is not enough with it. Additional elements such as the attribution of operations to PEs (judgment of 20-2-1997, DFDS, C-260/95), the relationship with their headquarters (judgments of 23-3-2006, FCE Bank, C-210/04, 17-9-2014, Skandia America (USA), C-7/13, or 24-1-2019, Morgan Stanley, C-165/17) or their impact on the right to deduction (judgments of 27-3-2014, Le Crédit Lyonnais, C-565/12, or 24-1-2019, Morgan Stanley, C-165/17) have also been analysed by the ECJ.
Unfortunately, all these elements, crucial in the levying of VAT in international operations, lack the appropriate harmonized regulatory approach, with all that this implies in terms of the lack of generality or overall vision in the criteria on which their taxation is built.
In addition, it has to be remembered that, in general, economic or factual approaches, focused on the final results of some existing structures, have not been easily accepted by the ECJ (judgments of 17-7-1997, ARO Lease, C-190/95, 16-10-2014, C-605/12, Welmory, or 12-17-2015, WebMindLicenses, C-419/14), with the only exception of the outcome of 20-2-1997, DFDS, C-260/95).
The stance of the VAT Committee
In 2015 the VAT Committee was asked whether the concept of PE also applies to the supply/acquisition of goods (since the aforementioned definition of the VAT Implementing Regulation refers solely to services). On this occasion, the VAT Committee concluded that a taxable person cannot create a PE if it solely supplies goods, without supplying services. Moreover, the VAT Committee clearly mentioned that the mere existence of a warehouse in a Member State does not allow in itself to characterize this as a PE in that jurisdiction (working paper 857).
While this was the approach in 2015, in June 2019, the VAT Committee in the context of the 2020 VAT quick fixes (i.e. short-term improvements for intracommunity trade) changed its opinion stating that, a foreign company who supplies goods based on a call-of-stock arrangement and owns or runs (directly or indirectly) the storage, is deemed to have a FE in that member state. This is somewhat contradictory with the opinion of 2015 and shows the change in approach through time of the VAT Committee (note: we consider that this change is also due to the BEPS Action 7 Permanent Establishment status).
The delegates raised the issue whether for the purposes of Article 17a of the VAT Directive the supplier could be the stock keeper in the Member State of arrival of the goods without necessarily being seen as having a fixed establishment for VAT purposes there.
This is a relevant question as one of the conditions for the call-off stock simplification to apply is that the supplier has not established his business nor has a fixed establishment in the Member State to which the goods are dispatched or transported. Therefore it is important to know whether the supplier having a warehouse to which he moves his own goods would automatically be excluded from the call-off stock arrangements simplification because of him being seen as having a fixed establishment in the Member State of the arrival of goods.
In order to detail its views, the VAT Committee went into detail on various scenarios that could arise:
- Firstly, in the situation where the warehouse is owned and run by the acquirer or in the case where the warehouse is owned and run by a third person, different from the supplier and the acquirer, the committee is of the opinion that this (call-off stock) warehouse is not a fixed establishment of the supplier.
- Secondly, in the situation where the supplier owns the warehouse, in the Commission services’ opinion, he does have a sufficient degree of permanence/material link with the warehouse to see it as creating a fixed establishment for him. This would be so regardless of whether he is running the warehouse himself or rents it out to another person.
- If the supplier, apart from owning the call-off stock warehouse, is also running it (indirectly or through his own employees) with the aim of supplying the goods to his clients then he should be seen as having a suitable, sufficiently permanent, structure not only in terms of technical resources but also in terms of human resources, which allows to consider the warehouse as his fixed establishment in the Member State where it is located.
- If the supplier is renting the warehouse to a third person (who still allows the supplier to store his own goods there) then the supplier is providing a rental service, the warehouse being the object of that rental service. It seems that the warehouse should be seen as an establishment characterized by a sufficient degree of permanence and a suitable structure in terms of human and technical resources to enable the supplier to provide the rental service. The warehouse would therefore have to be seen as his fixed establishment (of the supplier) in the Member State of arrival of the goods.
- Thirdly, and most interestingly in our view, the VAT Committee assesses the situation in which the warehouse is owned by a third party (who has rented it to the supplier) and where the supplier is also hiring an independent third party that will run it for him. According to the VAT committee, in this situation, the supplier should be seen as having a fixed establishment in the Member State concerned.