At the beginning of the year, I drew on the EU VAT Committee’s working paper on VAT and transfer pricing (here) to publish a post summarizing several concerns this issue raises (here).
Two months later, the Spanish Central Tax Court published a judgment that confirmed all my fears: the war against commissionaire structures in the direct tax field has VAT casualties, too (judgment of May 24, 2017; read the Spanish version here ).
Readers of this blog are well aware of the problems that commissionaire structures cause in the direct tax field. To those who are unfamiliar with these structures, in a nutshell, international groups that store goods in a country and appoint a local and associated entity to provide sales support services through limited-risk distribution schemes risk being treated as though they are operating through a local permanent establishment. This risk increases if, along with the limited distribution, another local entity also provides toll-manufacturing services. The Spanish tax inspectorate has a keen eye for spotting permanent establishments in commissionaire structures; we even have our own Dell case (here) and another involving a toll manufacturer in the vitamins sector (here).
Until now, we mistakenly assumed that exposures were limited to direct taxation. But the Central Tax Court judgment reveals a tax inspector’s assessment involving a foreign company producing and selling candy that operated in Spain through two subsidiaries: a toll manufacturer and a limited distributor.
The facts of the case will ring a bell to those who are familiar with commissionaire structures: shortly after its acquisition by a foreign multinational, a traditional Spanish manufacturer changed its business model. To implement this change, it first split into two companies through a spin-off: a manufacturing entity and a distributor. The foreign parent company signed two contracts: a toll-manufacturing agreement and a limited distribution agreement.
Under these contracts, the foreign parent company owned the raw materials and the finished goods that the toll-manufacturer produced. They were then stored at the manufacturer’s premises until the Spanish commissionaire sold them to clients. Under common VAT rules on commissionaire contracts, once a distributor completes sales with final customers, the VAT-able transaction between the foreign parent company and its Spanish commissionaire accrues for VAT purposes. The Spanish distributor must report this transaction via reverse charge, as the non-established parent company carries out the transaction.
However, the tax inspectorate did not accept the tax treatment the company applied and considered the foreign parent company as operating in Spain through a fixed place of business. It concluded that the delivery of goods to the foreign company from its associated distributor could not be taxed under reverse charge rules. Consequently, the foreign company should have invoiced the transaction from its Spanish fixed place of business, charging VAT on its remuneration.
Some might think this assessment is not so damaging, given that the company receiving the invoice (the limited distributor) should be entitled to a full VAT deduction. But remember that a substantial time lapse exists between the moment the VAT was not charged (when the transactions took place) and when it became deductible (when the tax inspectorate finished its tax assessment and a proper invoice documenting the chargeable tax was delivered to the distributor). Time is money, as we all know, and this is particularly true for the Spanish taxman, who is entitled to ask for late-payment interest calculated at rates that are indeed damaging.
The tax court’s judgment is exhaustive. Both the tax inspectors and the court’s chamber realized that the case was significant, given that many similar ones will follow. For this reason, the court judgment contained several pages that thoroughly analyzed the VAT concept of fixed place of business and its application to commissionaire structures.
Some of the grounds the tax court used are technically correct. But as I will explain, several are more than disputable.
To begin with, the tax court states that the concept of permanent establishment that applies to the direct tax field differs from the fixed place of business concept established in the VAT Directive. And the tax court is well aware of the distinction between both concepts and that the EU Court of Justice (FCE Bank, C-210/14) has established that commentaries on the OECD Model Tax are useless for VAT purposes.
However, the judgment also states that this distinction is more academic and theoretical than it is practical. The tax court stresses that both the permanent establishment and the fixed place of business concepts relate to the same underlying reality: an organization of human and material resources, weighty enough to carry out an economic activity on a permanent basis, run by an entrepreneur in another country. Therefore, though different in theory, in practice, cases in which a permanent establishment for direct tax purposes is not a VAT fixed place of business (or vice versa) seldom exist outside tax magazines.
The tax court’s reasoning is well-founded, especially when considering the judgment of the EU Court of Justice in DFDS A/S (c-260/95), where it interprets that, within a multinational travel agency group, a local subsidiary acting as an auxiliary agent of its parent company should be considered a fixed place of business. This landmark case brought about the traditional direct tax concept of “dependent agent” into the VAT field.
That said, to me it looks as though the tax court’s use of the DFDS A/S doctrine was not wholly justified. This is because the contract agreement that the Spanish distributor and its foreign company entered into revealed a high degree of autonomy, similar to the usual features of an independent agency relationship. The tax inspectorate used the Advocate General in DFDS A/S’s opinion that “the actual economic situation is a fundamental criterion for the application of the common VAT system,” a statement taken out of context that allowed it to deviate from the contracts’ wording.
This statement, which the Court of Justice endorsed in paragraph 32, is an alarming tool in the hands of the tax inspectorate, as it hints at a “substance over form” approach that, taken to the extreme, could allow tax inspectors to ignore contractual obligations, defending the tax treatment that best suits their economic take on a particular transaction.
For many years, we have known that abuse goes against the spirit of VAT, and that preventing possible tax evasion, avoidance and abuse is an objective recognized and encouraged in the VAT Directive (Halifax, C-255/02). But this same jurisprudence on VAT and the abuse of law is a reminder that legal certainty is crucial in the VAT field, and it must be observed strictly. In other words, anti-abuse measures cannot apply when economic activity may have an explanation beyond merely attaining tax advantages. This means that, in the VAT sphere, the contractual obligations signed between parties must be generally observed, giving tax inspectors little room to deviate from their ordinary tax treatment under the guise of pursuing a different economic end. This is particularly true in a case like the one at hand, where the companies involved were fully entitled to VAT deduction and no real tax fraud was feasible. The tax inspectors simply rejected the application of the reverse charge and asked for a direct charge of VAT in the supplier’s invoices. This seems to be a technical disagreement, and is far from being a tax fraud, allowing for the re-characterization of transactions under the abuse of law doctrine.
What is more, I see an inconsistency in the tax court’s judgment and the underlying tax inspectorate’s assessment, which may be enough for the upper court to annul it. The final outcome of the tax assessment is that the foreign company operated through a fixed place of business in Spain because of the permanent amount of resources available at its two Spanish subsidiaries (the toll manufacturer and the limited distributor).
But the tax inspector asked for details on the delivery of goods between these two “deemed” permanent establishments. This clearly goes against current EU case law, under which the branch of a non-resident company is not independent, meaning the branch and its head office must be considered one and the same taxable person within the scope of the VAT Directive (FCE Bank, C-210/14). This doctrine clearly applies to relations between two permanent establishments, as they are plainly part of the same taxable entity.
To sum up, a careful reading of this case should take us back to basics: VAT and direct taxation are shaped by distinct principles, and the traditional challenges against commissionaire structures under OECD direct taxation principles may not be a good fit for the VAT field. Despite tax inspectors’ blatant attempts at extending this issue to VAT, it seems wholly unjustifiable to use substance over form techniques merely to look for late-payment interest arising from VAT reported through the reverse charge rule. Let’s see what the upper courts make of it all.
