VAT, fixed establishments and supplies into the UK using a related UK party

An overseas company which supplied insurance through a related company in the UK did not have a fixed establishment in the UK. Accordingly, supplies by the UK broker to the company were supplied outside of the EU and the broker was able to recover input tax attributable to those supplies.

The First Tier Tribunal (FTT) has held that a UK company carrying out client facing insurance selling and claims handling activities for a related Gibraltar entity was not a “fixed establishment” of that Gibraltar entity for VAT purposes. Whilst the totality of the functions required to operate an insurance business were essentially split between the UK company and the related Gibraltar entity, the two sides of the business remained separate and the UK company acted as a separate business with its own commercial aims: Hastings Insurance Services Ltd v HMRC [2018] UKFTT 27.

The decision provides a useful review of the relevant case law on the question when one independent person may amount to a fixed establishment of another, focussing on the question whether the control exerted by the latter over the former is sufficient to meet the criteria of a fixed establishment. The fact that the two related entities dealt with each other on arm’s length commercial terms and had separate decision making boards made it clear that there was not the requisite level of control for the UK company to be treated as a fixed establishment of the overseas company.

Background

Advantage was a Gibraltar based insurance company. It had its own board and decided on what risks to insure and what prices to charge. It entered into policies with customers and met claims made by insured customers. Hastings was a related UK entity, but again with a separate board and business functions. It dealt with the customer facing side of the insurance business for Advantage under commercially agreed contractual arrangements. It sold insurance policies to customers on behalf of Advantage and handled subsequent smaller claims. It also provided technical and analytical support to enable Advantage to carry out its underwriting function. It was recompensed via commissions which it charged, together with performance related commission relating to claims handling. It also acted as a broker and claims handler for other insurers, though on a much smaller scale.

Hastings sought to recover input VAT which it incurred in relation to its insurance broking, underwriting support and claims handling services made to Advantage. It contended that the input VAT was recoverable as it related to its insurance related supplies made to a taxable person outside the EU (under the input VAT recovery rules relating to “specified supplies”). HMRC disagreed and argued that Hastings effectively amounted to a “fixed establishment” of Advantage in the UK. Whilst HMRC did not dispute that Advantage had a “business establishment” in Gibraltar, HMRC contended that the input VAT was connected with supplies made to the UK fixed establishment. As such, the input VAT was not recoverable.

Fixed establishment?

The FTT decision contains a long and in-depth analysis of the case law concerning the meaning of “business establishment” and “fixed establishment” for VAT purposes. HMRC’s arguments heavily relied on the earlier European Court of Justice (ECJ) decision in DFDS where it was held that the UK subsidiary of a Danish travel company amounted to its “fixed establishment” in the UK for the purposes of holiday sales. In contrast, the appellant contended that the DFDS decision was not of general applicability and relied on the more recent ECJ decision in Welmory. In that case, the Advocate General doubted that it was in accordance with the principles of legal certainty for a taxable person (as opposed to its resources) to be regarded a fixed establishment of another taxable person. Whilst the ECJ did not directly comment on that position, the ECJ did reject the argument that the fact that the economic activities of two companies, which were linked by a cooperation agreement, formed an economic whole was material for determining whether a Cypriot company possessed a fixed establishment in Poland.

The FTT considered that it has been established in the case law that there are two inter-related elements to what is required for there to be a fixed establishment: (i) the establishment must be of a minimum size with the human and technical resources necessary for making/receiving the relevant supplies; and (ii) those resources must be “permanently present” or, put another way, the establishment must have a “minimum degree of stability derived from the permanent presence of human and technical resources”.

It was the issue of how to apply this test of “permanence” or “stability” to arrangements involving subsidiaries or other cases with close connection that was core to the dispute. Whilst noting the differences of approach between DFDS and Welmory cases, the FTT considered that they were not inconsistent. Indeed, the FTT rejected the appellant’s contention that DFDS should be regarded as of only limited application to supplies of travel agents.

In Welmory, the Advocate General rejected the contention that share ownership or common control was relevant to the test of permanence. The correct question was what direct rights the relevant entity had over the resources themselves in Poland. In DFDS, the court said the fact that the English subsidiary was wholly owned by the Danish parent indicated dependence on the parent. However, that alone was not determinative. It was also pointed out that the subsidiary had heavy constraints on its activities. As such, both approaches require consideration of the nature of the contractual arrangements between the parties as regards the degree of control conferred over the underlying resources/functions or correspondingly the degree of dependence or lack of independence of the relevant entity/its resources.

However, in this case, under the contractual arrangements in place, the totality of the functions required to operate an insurance business were split between the two entities, in effect. The parties were linked but were operating different parts of the same business under what were, inevitably, close economic, commercial and operational links. Nevertheless, the FTT accepted that both had distinct functions and operated separately and independently such that it could not be said that Advantage had the required level of control over Hastings (or alternatively Hastings was not acting independently of Advantage). The fact that the two businesses were mutually dependent on each other for their success did not detract from the conclusion that Hastings operated independently in accordance with its own commercial objectives. Indeed, it was clear from the ECJ decision in Welmory that the fact that parties operate in close cooperation as part of a single economic activity is not of itself determinative of whether one forms a fixed establishment of the other.

Accordingly, the FTT noted that “the fact that a business delegates or outsources functions which it could otherwise carry out itself, on a basis which is commercially agreed as though the parties were independent, the very fact that the service provider acts within the commercially agreed parameters does not mean that the permanence requirement is satisfied. In other words, we cannot see that, in such circumstances, the setting of the scope of the service provider’s functions itself necessarily amounts to the required retention of control over the relevant resources or demonstrates the required lack of independence.”

Business establishment or fixed establishment?

Even if the FTT were wrong and Hastings (or its resources made available to Advantage) did amount to a fixed establishment of Advantage, it would still be necessary to decide if the supplies were made to the business establishment of Advantage in Gibraltar or the fixed establishment in the UK. HMRC argued that once it was established that Advantage made its supplies through the UK fixed establishment, it followed it would also be irrational to treat the business establishment as the place of supply/belonging as regards the services provided by Hastings. In HMRC’s view the actual economic situation was that the services were “predominantly” used or consumed at the UK fixed establishment to market and sell insurance to UK customers. Moreover, to tax by reference to the business establishment would, therefore, enable Hastings to recover input tax on exempt supplies made in the UK thereby leading to potential distortion of competition.

The FTT rejected these arguments. It was not disputed that Advantage was an insurer operating its business in Gibraltar with its own staff and resources located there (even if it also had a UK fixed establishment through Hastings). At the very least, some of the services provided by Hastings related to those activities carried out in Gibraltar and it was certainly not the case that those used in Gibraltar were only “ancillary”. Since the FTT rejected HMRC’s contention that the services “predominantly” related to the activities in the UK, and considered that the services were used in an unidentifiable and non-quantifiable manner, this was precisely the type of case in which it was legitimate to fall back on the business establishment as the place of supply/belonging on the basis that the business establishment normally takes primacy over the fixed establishment.

As such, the FTT held that the input VAT was recoverable on the basis that it was attributable to supplies made by Hastings to Advantage which belonged outside the EU.

Comment

In 2016, 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, issued an opinion expressing concern that there was “increasing evidence that tax authorities incorrectly conclude that an FE exists on the basis of the existence of PE, and vice versa” and agreeing with the opinion that “DFDS must be viewed as an exceptional case on its facts not…capable of general application”.

The FTT has not gone so far as to accept that the DFDS decision, and the concept that a subsidiary may be a fixed establishment of its parent, is not of general application, however, it does seem clear that the cases where it will be applied will be extremely circumscribed. In particular, it will not be applicable to cases where functions are outsourced to a subsidiary or even where (as here) a single business is essentially split, provided that the subsidiary retains its own economic independence.

In this context, the decision highlights the importance of having an independent management structure in place. In addition, the two companies had contractual agreements in place, which had been negotiated on a commercial basis and which governed the services provided between them. Both these factors were important in indicating that Hastings was not a fixed establishment of Advantage.

Nevertheless, cases concerning the existence or otherwise of a local fixed establishment are extremely fact sensitive and the guidance on whether the necessary resources exist with the requisite degree of control and permanence provides no bright lines. As such, each case must be determined on its own, specific facts.

Update

For details of HMRC’s proposals to counter the “offshore loop” arrangements in this case, see “Specified supplies of financial services: possible restrictions on input VAT recovery”.

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