CJEU’s decision on whether a subsidiary can constitute a fixed establishment for VAT purposes

The concept of FE has been long-debated before the CJEU since the landmark DFDS case (C-260/95) and the judgments that followed (i.e. Welmory, C-605/12, Budimex, C-224/18). At the same time, the approach of tax authorities in several EU Member States to challenge the business models of foreign-based companies with tolling arrangements and sales support & marketing functions in their territories has raised controversy on the application and limitations of the FE concept.

The Dong Yang case may finally bring some clarity on the criteria that businesses should consider in order to address the risk of fixed establishment.

Background

Dong Yang Electronics sp. z o. o., a Polish-based entity, entered into a contract with LG Display Co. Ltd., a company established in South Korea (“LG Korea”), for the provision of services consisting in the assembly of printed circuit boards. The materials were imported in Poland and delivered to Dong Yang by the Polish subsidiary of LG Korea (“LG Poland”). Upon assembly, Dong Yang turned over the products to LG Poland to be used as components for the further production based on the services agreement between LG Poland and LG Korea. The finished products were then sold by LG Korea to another Polish subsidiary for onward sale on the European market.

Dong Yang issued invoices for the assembly services without Polish VAT on the basis that the services were provided to LG Korea and the latter assured Dong Yang that, even though it was VAT registered in Poland, it did not have a fixed establishment, employ staff, own property or have technical equipment there. However, the Polish tax authorities considered that Dong Yang should have charged Polish VAT on its invoices on the grounds that LG Poland acted as a fixed establishment of LG Korea. According to the Polish tax authorities, in light of the contractual relationship between LG Korea and LG Poland, Dong Yang should have examined the use of the assembly services and assessed that the Polish subsidiary was the actual beneficiary in its capacity as fixed establishment of its foreign parent entity.

CJEU judgement

The Court was asked firstly to consider whether the mere fact of existence of a subsidiary is sufficient for this entity to constitute a fixed establishment of the foreign-based parent company. The CJEU reminded in this regard that the legal form of the entity is not relevant in order determine whether such entity can qualify as a fixed establishment for VAT purposes.

As the Court pointed out, the concept of fixed establishment relies on material conditions being fulfilled, namely the existence of: “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” (Art. 11 of the Council Implementing Regulation 282/2011). Furthermore, the fulfilment of these conditions should be examined on a case-by-case basis, in the light of the economic and commercial reality of the operations in question. As a result, the Court clearly dismissed that the simple existence of a subsidiary could be perceived as fixed establishment of the foreign-based parent entity.

The Court further recalled that a service provider, such as Dong Yang in this case, should follow the specific criteria outlined in Art. 22 of the Council Implementing Regulation 282/2011 to determine whether the services should be attributed to the legal seat or the fixed establishment of an entity. These criteria consist in examining the nature and use of the services provided to deduce who is the actual beneficiary of the services. Where these elements are not sufficient, the contract, the customer order and VAT identification number communicated to the supplier are decisive factors.

In this respect, the Court concluded that requiring from the service provider to further investigate the contractual relationship between the client entities would go beyond the diligence obligations that are required, particularly where the service provider does not have access to such information.

Key takeaways

• At first glance, the Dong Yang judgement brings more certainty on the long-debated topic of VAT fixed establishments as it confirms that the mere presence of a subsidiary is not sufficient to constitute a fixed establishment of a foreign-based parent entity. This could narrow the risk of qualification of fixed establishment, especially in cases where the main characteristics of FEs are absent.

• Crucially, the Court insisted on the principle of substance over form: the qualification of fixed establishment should rely on material conditions and be assessed on the basis of the economic and commercial reality. Businesses should carefully consider that contractual and other formal arrangements could be reversed, if they are inconsistent with the economic reality of the transactions.

• It is also important to note that the CJEU did not go as far as dismiss completely the possibility that a subsidiary can qualify as a fixed establishment (i.e. which was inferred from the position in the Advocate General’s Opinion on this case). Similar to the Welmory case, the Court has left the door open by stating that the qualification of a subsidiary as a fixed establishment cannot be excluded if the material conditions are fulfilled.

• Therefore, companies engaged in multiparty service agreements and manufacturing arrangements that may involve also intra-group flows should be vigilant, as these transactions could still trigger debate on the existence of local FEs. Assessing the role and functions attributed to these entities and setting up robust diligence processes to identify the recipient of the services are key to mitigate the risk of VAT re-assessments along the business model.

For further information or in case of any questions, please contact Tomasz Kassel, tomasz.kassel@pwc.com or Joanna Poznańska-Poremba, joanna.poznanska@pwc.com.

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