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HMRC internal manual

VAT Place of Supply of Services

Establishment making or receiving the supply: The irrationality test

In DFDS A/S the Court refined the Berkholz irrational result test. It supported the Advocate General’s opinion that the fundamental criterion was to apply the VAT system in a manner as far as possible which reflects the actual economic situation. It found that the term fixed establishment was included as an alternative to ‘the place where the supplier had established his business’ specifically to take account of the possible diversification of a business’s activities in different places in the Community. It found that systematic reliance on the place where the supplier had established its business could lead to distortions of competition by encouraging businesses in one Member State to establish their businesses, in order to avoid taxation, in another Member State which treated the services as exempt (under a derogation).

There has been no systematic analysis of what would constitute an inappropriate or irrational result for VAT purposes, but if any of the following points are relevant, there are likely to be sufficient grounds to treat an establishment other than the head office as the one most directly concerned with the supply, in the following circumstances

  • non-taxation - if the head office is in one Member State but supplies are actually made from an establishment in another Member State where they are exempt from tax. Similarly, if the head office is outside the EC, supplies of those services whose place of supply is where the supplier belongs may escape taxation altogether. Place of supply rules do not guarantee taxation in all cases, but the general aim of the Directive is to bring business activities conducted within the EC and services consumed within the EC within the scope of EC VAT.
  • distortion of competition - between suppliers of similar services, whether within a Member State or across borders
  • double taxation or disputes - with other Member States
  • head office involvement in making the supplies is minimal or non-existent

In Chinese Channel Ltd (HK) (CO 1377-96) the High Court questioned whether the business establishment test or fixed establishment test predominated. It said that a taxing authority cannot apply the fixed establishment rule merely because there is a fixed establishment in its territory from which the service is provided. It can only do so if the preliminary test of business establishment does not lead to a rational result or causes conflict between member states. It was not convinced by Customs’ argument that choosing a business establishment outside the EC in preference to a UK fixed establishment was irrational because it lead to non- taxation. The Court considered this was relevant only to services which fell within Article 9(3) services (services supplied where used and enjoyed). The High Court made it clear that these remarks formed no part of its decision. Accordingly, we consider that the policy set out in this section is unaffected.

Before giving an appealable decision that a UK fixed establishment is most directly concerned with a supply you must obtain firm evidence that the supply is made from, or received at that establishment. If you are in any doubt, please contact the VAT Supply Team.