Fixed Establishment: The ins and outs of a tricky VAT concept

As soon as a business operates in more than one country, working out VAT suddenly becomes a lot more tricky. One of the central concepts to bear in mind, in such cases, is place of supply. 

Place of supply is where the goods or services are deemed to have been supplied, for VAT purposes. If that sounds a little obvious, the practical point is that the place of supply determines where VAT is owed.

When a business operates in a country and supplies services in that same country, it can be simpler to determine. For example, suppose Company A is based in France. Company A supplies services to Company B, which is also located in France. The place of supply is clearly France and VAT is due to French tax authorities. However, even in this scenario, there could be exceptions to the basic rule.

In the case of cross-border supplies of services, things get a little trickier. Under broadly accepted VAT rules, when a company supplies services to a VAT-registered business in another country, then the place of supply is the country in which the customer is located. For instance suppose Company A, established in France, supplies services to Company C, based in Germany. In that case, VAT is due in Germany. In other words, for B2B supplies between VAT-registered businesses, place of supply is where the buyer is established.

Things are different when it comes to cross-border supply of B2C services (supplies to private customers). In such cases, VAT is generally applied at the place where the supplier is located.  

If that’s not complex enough, what happens when the supplier has a local presence where the customers are based? If the supplier is established in the county in which customers are located, then VAT is often due in the country in which the supply is made.

Ok, now here’s where things get really complicated. When, for VAT purposes, can we say that a company has a branch in a given country? There are open and shut cases: a company opens a fully-fledged branch in another country, hires staff, and sets up permanent premises. 

Where tax authorities hold that a Fixed Establishment exists, then the company has a VAT liability in that specific country.  Recently, the definition of FE was tested in the EU courts. 

To get a better sense of some of the complexity of determining whether an FE exists, let’s take a quick look at the outcome.

When is a fixed establishment a fixed establishment? 

In April 2022, the CJEU heard a case involving Berlin Chemie AG, a German pharmaceutical company. 

The case deals with an important question in terms of clarifying the criteria for a fixed establishment. In this case, Berlin Chemie has contracted services out to Berlin Chemie A. Menarini SRL, a company established in Romania. The Romanian company is wholly owned by Berlin Chemie/Menarini Pharma GmbH, which is in turn 95% owned by Berlin Chemie AG. That is, the German company is the majority shareholder in the Romanian business.

The Romanian company markets and supplies Berlin Chemie’s products in Romania. In doing so, it follows the German company’s strategic direction.  

According to Romanian tax authorities, there was a FE in place, therefore a significant amount of Romanian VAT was due.

However, the referring court asked an important question: “is it necessary for the human and technical resources employed by that company in the territory of that Member State to belong to it, or is it sufficient for that company to have immediate and permanent access to such human and technical resources through another affiliated company which it controls since it holds the majority of its shares?”

In this case, the human and technical resources do not ‘belong’ to the German company? So are the criteria for fixed establishment actually met?

Defining necessary criteria for Fixed Establishment. 

The CJEU noted two factors as particularly important. First, the Romanian company was formed specifically to provide exclusive services in Romania for the German company. Second, the supply of products to Romania by the German company is long-standing and stable. 

Ownership of employees

Interestingly, the court found that while the Romanian company’s staff did not ‘belong’ to the German company, “the German company had the technical and human resources of the Romanian company at its disposal as if they were its own that the German company could have a suitable structure with a sufficient degree of permanence in Romania.” That has important implications for future FE cases.

But that was not the only criterion on which the court made its case.

Who is servicing whom?

The court also found that the resources available to the German company via the Romanian company are also the resources through which the Romanian company supplies services to the German company. However, the court found, “the same means cannot be used both to provide and receive the same services”.

Specifically, the German company receives advertising and other services, which it uses to sell in Romania. 

“If those facts are established, which it is for the referring court to verify, the German company does not have a fixed establishment in Romania, since it does not have a structure in that Member State allowing it to receive services there provided by the Romanian company and to use those services for the purposes of its economic activity of selling and supplying pharmaceutical products.”

That is when a parent and subsidiary company are established in two different EU member states, the existence of the subsidiary does not in itself create a fixed establishment for the parent company. In this case, the subsidiary is rendering services to its parent, Berlin Chemie. It cannot at the same time be held to receive services from the parent company.

The takeaway 

The ruling raises two important VAT issues. Firstly, a company does not need to ‘own’ human and technical resources to create a fixed establishment

At the same time, the mere existence of a subsidiary does not create FE for the parent company. In the case where the subsidiary provides services to the parent company, it cannot constitute FE as this would mean that the subsidiary cannot be held to both receive and provide services at the same time. 

Whether or not a Fixed Establishment exists is a question of fact. However, the facts of the matter are proving harder to pin down than lawmakers may have anticipated. 

Businesses with cross-border operations should not be complacent about their VAT liability. The rules are sometimes ambiguous and the case law is evolving. 

At VAT IT, we are carefully monitoring regulatory developments across the EU. Our expert VAT team can provide you with detailed, strategic VAT advice that considers your entire supply chain. 

Contact VAT IT to bulletproof your VAT compliance and stay one step ahead of changing VAT regulations.