Advocate General calms fears of VAT risk from outsourcing to the EU

A recent opinion from the Advocate General (AG) of the Court of Justice of the European Union (CJEU) has provided more clarity on the VAT position of UK businesses that outsource work to affiliates established in the EU. 

If supported in the court’s final judgment, this finding may make it more difficult for EU tax authorities to penalise foreign businesses by arguing that their use of a local affiliate’s staff and technical resources in an EU member state creates a ‘fixed establishment’ there for VAT purposes.

Why is this important?

In recent years, the CJEU has heard several VAT cases which consider whether outsourcing manufacturing or other services to an affiliated business in an EU member state creates a fixed establishment of the user in that country.

Should that be the case, the foreign business may be required to retrospectively register for VAT in that EU member state and pay local VAT on the outsourcing fee charged to it by its affiliate. 

While in many cases there may be no net tax at stake, some EU member states may levy substantial penalties for failing to register for VAT on time. Also, due to the short deadlines for submitting claims for refunds of VAT paid in the EU by foreign entities, businesses may find themselves unable to recover any local VAT that should have been charged to them. 

Concerns raised by recent case law

The 2022 judgment of the CJEU in the case of Berlin Chemie found that the use of staff and technical resources belonging to another entity in an EU member state is potentially capable of creating a fixed establishment of the user in that country. Although the court believed that the precise arrangement used by Berlin Chemie did not create a fixed establishment, it also stated that the entity concerned does not have to necessarily own the resources itself for them to create a fixed establishment for VAT purposes, provided it is able to use them as if they were its own.

This raised concerns amongst businesses that outsource manufacturing or local sales/promotion to a group company in the EU, that their close affiliation could meet this legal test and put them at risk of VAT assessments and penalties from the tax authority in the relevant member state. 

The latest development

The CJEU has now been asked to consider another case, this time concerning a manufacturing contract between two companies in the Adient group, a global automotive business. An Adient group company in Germany outsourced the manufacture of car seat covers to another group company in Romania. Under the VAT place of supply rules, the Romanian company regarded its manufacturing service as being subject to VAT in Germany (where its customer was established) and treated the supplies as outside the scope of Romanian VAT.

However, the Romanian tax authority ruled that the contract gave the German company a fixed establishment in Romania, which would have meant that Romanian VAT was chargeable on the manufacturing contract. In the ensuing appeal, the matter was referred to the CJEU for a ruling on the correct VAT position. 

In her opinion released on 1 February 2024, the AG first stated her view that a company does not act as a fixed establishment of another company solely because they are both members of the same corporate group. She then added that a contract for services alone (such as toll manufacturing or sales representation) is unlikely to be sufficient to create a fixed establishment for the user. To do that, the contract would have to provide the human and/or technical resources at that site that are similar to those provided at a head office.

This is good news for UK outsourcers as, if upheld in the final judgment, these findings would significantly narrow the circumstances in which EU tax authorities could argue that a foreign outsourcer has a fixed establishment in their country. According to the AG, simply holding a contract for other services, such as processing goods or perhaps even quality control or acting as a regional sales representative, is not enough to create a fixed establishment. A fixed establishment would only be created by a contract that seeks to provide human and technical resources that will act as a ‘local head office’ for the foreign outsourcer.

We now await the court’s final judgment, which is expected to appear in late spring or summer of 2024. 

Action points

Organisations that use the resources of foreign affiliates based in the EU should check how such rights are described in their contracts and compare their circumstances to the findings in this and other relevant case law, working with their professional advisers to identify and manage the consequences.

With regard to the issues raised in Berlin Chemie, they should pay particular attention to whether their contracts give them permanent and uninterrupted access to their affiliate’s human and technical resources which cannot be terminated at short notice, and whether the services provided by their affiliates are of a different nature to the supplies they make themselves in the affiliate’s territory.

They should also watch out for the court’s final ruling in Adient to see if it upholds the AG’s findings that, to create a fixed establishment for VAT purposes, the contract must provide resources akin to a local head office to the outsourcer. If the court agrees with the AG’s views on that key point, it may be necessary for businesses with outsourcing arrangements to demonstrate to the tax authority that their contracts accurately describe the reality of the services provided between the two entities.

For more information, please get in touch with Andy Ilsley or your usual RSM contact.