VAT: subsidiaries as fixed establishments

The ECJ has held that a supplier is not required to carry out significant due diligence to determine whether their supply is to a fixed establishment of a foreign entity: Dong Yang Electronics v Dyrektor Izby Administracji Skarbowej we Wrocławiu (Case C 547/18) (ECJ, 7 May 2020). The ECJ recognised that a supplier cannot be expected to examine the contractual relationships between group entities to determine whether a subsidiary is a local fixed establishment of a foreign entity in order to determine the correct place of supply.

The decision provides a pragmatic approach to the application of the place of supply rules. However, it is important to note that the decision relates to the position of a supplier needing to determine the place of belonging of their customer in order to determine the correct place of supply. It is, therefore, quite possible that the position may be different where the place of supply is determined by the place of belonging of the supplier and intra-group arrangements are in place between parent and subsidiaries which indicate that the subsidiary may be a fixed establishment of the parent. In those circumstances, it may be that the approach advocated by the Advocate General (AG), based on the existence of abuse, may remain the appropriate approach.

Background

The case concerned supplies of services made by Dong Yang under a contract with LG Korea involving the assembly of circuit boards. In practice, the circuit boards were provided to Dong Yang by LG Poland Production, a subsidiary of LG Korea. Following processing, Dong Yang also returned the boards to LG Poland Production.

Dong Yang did not charge Polish VAT on its services to LG Korea as LG Korea assured Dong Yang that it did not have a fixed establishment in Poland, did not employ staff, own property or have technical equipment in Poland. As such, Dong Yang treated its supplies of services as taking place outside the EU.

LG Poland Production assembled LCD modules owned by LG Korea under its own contractual arrangements with LG Korea. It also provided storage and logistics services in connection with the finished goods owned by LG Korea. The finished goods were sold by LG Korea to another Polish subsidiary which then sold them on the European market.

The Polish tax authorities took the view that Dong Yang’s supplies should have been subject to Polish VAT as, properly analysed, they were made to a fixed establishment of LG Korea in Poland in the form of LG Poland Production. The matter was referred by the Polish courts to the ECJ.

The Advocate General (AG) opined that, in the absence of abuse, a separate legal entity such as a subsidiary should not be capable of being treated as a fixed establishment of another entity.

Decision of the ECJ

The ECJ has taken a somewhat different approach to the question than the AG. In particular, the ECJ focused on the position of the supplier, who, in a case like this, is required to determine whether its supply is to a local entity incurring domestic VAT or to a non-local entity and thus outside the scope of domestic VAT.

The ECJ first noted that the mere fact that the subsidiary was a separate entity did not prevent it being a fixed establishment of the Korean parent company. “It cannot be ruled out that the subsidiary held for the purposes of conducting economic activity by the parent company established in South Korea may constitute a fixed establishment of that parent company in a Member State of the European Union, within the meaning of Article 44 of Directive 2006/112.” In this context, the ECJ stressed that “consideration of economic and commercial realities form a fundamental criterion for the application of the common system of VAT.... Therefore, the treatment of an establishment as a fixed establishment cannot depend solely on the legal status of the entity concerned”.

However, it was important to note that Article 22 of the Implementing Regulation (No 282/2011) provides important guidance on the criteria which the supplier of services must take into account in order to identify the customer’s fixed establishment. “First of all, it must examine the nature and use of the service provided to the taxable person constituting the customer. Next, where that examination does not enable the fixed establishment of that customer of the service to be identified, it is necessary to pay particular attention to whether the contract, the order form and the VAT identification number attributed by the Member State of the customer and communicated to him by the customer identify the fixed establishment as the customer of the service and whether the fixed establishment is the entity paying for the service. Lastly, where the two abovementioned criteria do not enable the fixed establishment of the customer to be identified, the supplier may legitimately consider that the services have been supplied at the place where the customer has established his business.”

It was clear from Article 22, therefore, that a supplier is not “required to examine contractual relationships between a company established in a non-Member State and its subsidiary established in a Member State in order to determine whether the former has a fixed establishment in that Member State”.

Accordingly, the ECJ held that the existence, in the territory of a Member State, of a fixed establishment of a company established in a non-Member State may not be inferred by a supplier of services from the mere fact that that company has a subsidiary there, and that supplier is not required to inquire, for the purposes of such an assessment, into contractual relationships between the two entities.

Comment

The ECJ’s decision highlights the specific circumstances of this case where the onus was on the supplier of services to determine if its customer has a local fixed establishment to which its supplies are made. In those circumstances, it would be contrary to the fundamental principles of the VAT system to place the onus of examining the contractual relationships between the customer and its local subsidiaries on the service provider.

However, since the ECJ focused on the position of a supplier to a group, it may be that different consideration may apply where the place of supply depends on the location of supplier (rather than the customer) and there are group arrangements between a non-EU parent and local subsidiary which could impact on the place of supply. In those circumstances, the inability of a service provider to determine the contractual relationships between the non-EU parent and local subsidiary would not be an issue.

It is perhaps disappointing, therefore, that the ECJ chose not to analyse its earlier case law on this issue, such as the DFDS case in which the ECJ held that a subsidiary might be a fixed establishment if it were a "mere auxiliary organ". The AG chose to marginalise the case as specific to its facts and to the particular legal regime, involving the sale of holidays by an intermediary, under the Tour Operators Margin Scheme (TOMS). That decision was not "automatically transferable" to the current case as it was specific to the TOMS scheme, it involved an intermediary (which was not the case here) and, in addition, it involved a supply of services (not the receipt of services by a customer). The latter point may well remain relevant, however, in other cases where the place of supply depends on the location of the supplier. And it may be that the approach advocated by the AG and based on abuse would be appropriate in that situation where the question is whether a supplier has a fixed establishment in a jurisdiction (as in DFDS) and issues around a third party’s knowledge are less relevant.

It is interesting to note that the VAT Expert Group, a group comprising academics and experts from Member States set up by the European Commission to assist and advise the Commission, suggested in 2016 that a subsidiary might only “exceptionally give rise to a fixed establishment of the parent”. This opinion seems to remain in line with both the Opinion of the AG and also the decision of the ECJ in this case.