United Kingdom VAT & Duties Tribunals Decisions

Zurich Insurance Co v Revenue and Customs [2005] UKVAT V19157 (30 June 2005)

19157

PLACE OF SUPPLY OF SERVICES – consultancy services within article 9(2)(e) of the Sixth Directive – whether supplied to the head office in Switzerland or to the fixed establishment in the UK – to the head office – appeal allowed

LONDON TRIBUNAL CENTRE

ZURICH INSURANCE COMPANY Appellant

- and -

HER MAJESTY'S REVENUE AND CUSTOMS Respondents

Tribunal: DR JOHN F AVERY JONES CBE (Chairman)

CYRIL R SHAW FCA

Sitting in public in London on 16 (reading day) to 19 May 2005

Penny Hamilton and Richard Vallat, counsel, instructed by Bill Sandiford, Head of Group Tax, for the Appellant

Nigel Pleming QC and Adam Robb, counsel, instructed by the Acting Solicitor for HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2005


 


DECISION

1. This is an appeal by Zurich Insurance Company against an assessment to VAT dated 6 November 2002 for £2,085,153 in respect of periods 12/1999 to 12/2000. The Appellant was represented by Mrs Penny Hamilton and Mr Richard Vallat, and Customs by Mr Nigel Pleming QC and Mr Adam Robb.
2. The issue in this appeal is the place of supply of consultancy services by PricewaterhouseCoopers AG in Switzerland to the Appellant company relating to the installation of new financial accounting software known as SAP [SAP is the name of the German software company]: is it where the Appellant company is established (Switzerland), as the Appellant contends, or where it has a fixed establishment (the UK), as Customs contends? We are asked to determine this in principle leaving any figures to be determined later.
3. We start by clarifying our terminology. The Appellant Company is «Zürich» Vericherungs-Gesellschaft whose legal name in English is Zurich Insurance Company, which has places of business in many countries. We shall use the expression "the Appellant Company" when we intend to refer to the company as a whole; we shall refer to "the Group" to mean the Appellant Company (and its successor as head of the group, Zurich Financial Services, and their subsidiaries. We shall refer to the Swiss establishment of the Appellant Company as Zurich (HO), and to its branch in the UK as Zurich (UK), using both expressions primarily in a geographical sense. Accordingly where we say that, for example, Zurich (HO) contracted for something we fully appreciate that the Appellant Company is the contracting party but we mean that the place of negotiating and concluding the contract was at Zurich (HO).
4. We heard evidence from Mr J A Bottome, SAP-WW [WW means world-wide] Programme Manager based at Zurich (HO) in 1999 and 2000, and Mrs J C Stringer, who was concerned with the project at Zurich (UK) from October 1998 becoming Project Director for Project 1 in August 2001 and UKISA [UK (including the Channel Islands and the Isle of Man), Ireland and South Africa, one of the Group's regions for management purposes] Programme Director (responsible for the implementation of SAP in the UKISA region. In addition a witness statement of Mr N C Warner, Group Head of Indirect Taxes was admitted. We also had 7 lever arch files of documents.
5. We find the following facts:

(1) The Appellant Company was established in Zurich in 1873 and it is common ground that this is the place where it has established its business in terms of article 9(2)(e) of the Sixth Directive (see paragraph 5(23) below). Zurich (UK), its UK branch, was formed in 1922 and it is common ground that it is a fixed establishment in terms of the Sixth Directive. On 7 September 1998 the Appellant Company merged with the financial services division of B.A.T. Industries p.l.c. (which included Farmers Group based in the US, and Eagle Star and Allied Dunbar in the UK). The merger under the new parent company, Zurich Financial Services, created one of the world's leading insurance and financial services organisations with its headquarters in Zurich having about 500 group companies and employing over 68,000 people in over 50 countries. The Appellant Company is the largest general insurance company in the Group and operates from branches in many countries.

SAP generally

(2) SAP is a set of software tools used by many international businesses to keep business records, prepare accounts, monitor budgets, control costs and handle many other business process needs. Certain core modules were made compulsory throughout the Group. These are known as FI/CO [FI for financial records (comprising general ledger, accounts payable, accounts receivable, fixed assets and special ledger; CO for controlling (which tracks costs and works out profits for management reporting purposes, and comprises costs centre accounting, internal orders and profitability analysis)]. The output from SAP provided management reporting, regulatory reporting (such as insurance company regulation, direct tax and VAT) in sterling and based on UK GAAP [Generally Accepted Accounting Principles] for Zurich (UK), local reporting based on IAS [International Accounting Standards], and also information required by Zurich (HO) for Group reporting in other currencies and based on IAS with an addition for insurance company reporting known as NewZAP. Consolidation worldwide was performed by the output from SAP being passed through another system, Cormis.

(3) The contract for worldwide supplies between the Appellant Company and SAP (a Germany company) was concluded in Switzerland with a Swiss SAP subsidiary. The contract with IBM for the hardware was concluded with its Swiss IBM subsidiary

(4) Consistent management information requires common definitions of such things as premiums which is achieved by the use of modules common throughout the group. A standard template, known as Z-Core, was developed in Switzerland for this purpose. The framework agreement (see 5(6) below) explained it as "…a set of definitions and rules in order to allow the required central consolidation, visibility and overall benefits to be achieved." The SAP "starter kit" prepared for staff stated: "Z-Core is a SAP design that is intended to deliver group financial and management accounting reports prepared on a consistent basis, from individual business units to the group whilst retaining maximum flexibility for individual business units to add additional local configuration to meet their own local requirements." Z-Core was the starting point for local implementation and enabled local units efficiently to configure their own SAP systems. Preparation of Z-Core was one of the most costly elements of the entire project.

(5) Implementation of SAP worldwide in 70 business units in 50 countries was planned for a 2½ year period starting in October 1997. The merger that took place during this period made a common accounting system more urgent. The first version of SAP was launched in January 1998 in five pilot locations. Implementation in the UK, the US, France and Ireland was planned for 1999. Mr Bottome took over responsibility for implementation in January 1999. The whole project was managed by a series of committees based in Switzerland, of which the ultimate authority was the Executive Board in its capacity as Global SAP-WW Strategy Steering Committee. Below that was the SAP-WW Implementation Steering Committee chaired by Mr Bottome, which reported via the Chief Financial Officer to the Global SAP-WW Strategy Steering Committee. Below that were the Quality Management Panel, the Global Programme Manager (at this time Mr Bottome), the Global Programme Management, the Business Reference Group (later renamed as the SAP Advisory Council), and the Local SAP Implementation Steering Committee and Project Managers Group. Mr Bottome headed a team of 50 people in Switzerland. Communication worldwide used Lotus Notes that enabled those working on the project to see what was happening in other projects throughout the world and to learn by their experience.

(6) Price Waterhouse Management Consultants AG (a company registered in Zurich) were engaged as consultants to the worldwide project under a framework agreement signed, following four months negotiations, on dates between 15 and 31 March 1998 but effective from 24 November 1997 (when they had started work) and governed by the law of Switzerland with exclusive jurisdiction given to the Courts in Zurich. This agreement was novated to PricewaterhouseCoopers AG ("PwC AG") (also registered in Zurich) from 1 October 1998. The agreement stated the rates for work by PwC AG and other PwC entities. PwC AG gave a "Central Volume Discount" based on total billing on the Project by PwC entities worldwide, which was provided by monthly (later quarterly) credit notes. Mr Bottome renegotiated the terms of the discount and fees and expenses in March and December 1999.

(7) PwC staff were involved at all levels, two of them then based in Switzerland were members of the Implementation Steering Committee and also attended the Strategy Steering Committee as observers. Other PwC staff were appointed to all the overseeing bodies. The Group worked together with PwC staff as a team because while PwC knew about SAP they needed the Group's knowledge of its business systems and operations.

Implementation of SAP in the UK

(8) At Zurich (UK) SAP replaced another system, OLAS, that was performing similar functions satisfactorily since 1991 and was half way through a project of being upgraded, which had to be abandoned in mid-1998 when the decision was made to adopt SAP worldwide. There was resistance to the change from senior executives in the UK who were satisfied with OLAS.

(9) As a result of the merger the number of employees of the Group in the UK increased from about 3,000 to about 21,000. Following the merger there were at least 20 different, and incompatible, business and accounting systems in operation in the UK.

(10) A feasibility review of the implementation of SAP in the UKISA region was undertaken and the report made on 21 September 1998, shortly after the merger, stated that there was an urgent need to put in place a new accounting system for the non-life businesses in order to integrate the merged businesses. Another important requirement was that IAS reporting used by the parent company for external reporting was not possible under existing systems. The benefits of SAP were identified. Mrs Stringer allocated some of these to Zurich (HO), such as worldwide transmission of data, easier completion of year-end and interim reporting; others to Zurich (UK), such as easier consolidation of the results of local entities; and the remainder of the benefits accrued to the whole organisation, such as improved management information and easier inter-group charging. The report was considered at the Implementation Steering Committee meeting in Switzerland on 29 September 1998 and the start of the UKISA project from 2 November 1998 was approved at about the same time as the merger. Z-Core (version 2) was delivered to Zurich (UK) in January 1999.

(11) Implementation of SAP based on Z-Core in the UKISA region was split into five projects of which we are concerned only with part of Project 1 (UK non-life and group services); the other four projects concerned implementation outside the UK, and by life companies both in and outside the UK, and there was ultimately a further project involving the asset management business. Implementation by non-life business was carried out first as it enabled the Eagle Star non-life business to be brought into the same system as Zurich (UK). Since foreign branches of UK companies were included in Project 1, a total of 88 entities or branches in many countries (including the Bahamas, Hong Kong, Malta, Puerto Rico, Spain, Italy and Singapore, in addition to Ireland and Southern Africa) were involved in Project 1, including some that were not part of UKISA. Project 1 was originally estimated to require 60-man years work, which was revised in May 1999 to 146-man years; the cost estimate rose from £12.4m to £42m. Mrs Stringer was the UKISA Project Director for Project 1 and UKISA Programme Director for all the projects.

(12) The UKISA implementation work was carried out in accordance with Mr Bottome's standing instructions for Local Project Co-ordination. His team supported Mrs Stringer and her team, holding weekly telephone conference calls and running compliance tests for Z-Core from Switzerland by remote access. Local projects had to report progress on a weekly and monthly basis and these were consolidated into monthly reports to the Implementation Steering Committee.

(13) Zurich (UK) and the newly merged companies had various existing accounting systems (feeder systems) and a significant proportion (Mrs Stringer estimated it as 65%) of the cost of Project 1 related to changing the format of the files into the required SAP format (the interface hub). This percentage does not reflect the proportion of PwC AG's services because more Zurich (UK) staff were engaged on this aspect since they understood the existing systems. Z-Core, which was already in existence, could not function without this work.

(14) The framework agreement with PwC AG envisaged that work orders would be agreed relating to specific services and that "it may be appropriate" for local Zurich entities to engage local PwC entities for this purpose. Draft work orders were downloaded for completion by the appropriate PwC body and preliminary review by the local project manager followed by review by Mr Bottome. These went through many drafts (Mrs Stringer noted that Work Order No.2 went through at least 12 drafts, and No.5 at least 10). Negotiations were difficult because, although Mrs Stringer disapproved of some of the terms, these had been agreed in the framework agreement and she had to accept them until changes to that agreement were negotiated by Mr Bottome as mentioned above. Mr Bottome approved the Work Orders the subject of this appeal as required by the framework agreement.

(15) Work Order 1 of Project 1 (the programme initiation stage taking place between 26 October and 18 December 1998) was made between Zurich Financial Services (UKISA) Limited and the UK PricewaterhouseCoopers firm ("PwC (UK))" and is not involved in this appeal. Mrs Stringer took over negotiations of the first three Work Orders in February 1999 by which time the work under No.1 had already ceased. Services under Work Order 2 (programme and project management conditions for all the remaining work orders) started in January 1999 and continued until August 2000 and services under the other Work Orders all took place within this period. The nine Work Orders the subject of this appeal were eventually entered into between Zurich (HO) and PWC AG (or its predecessor) on 27 and 28 August 1999. PwC AG engaged PwC (UK) to carry out Work Orders 2 to 10.

(16) Until July 1999 fees were initially charged in sterling by PwC (UK) to Zurich (UK) and then re-charged to Zurich (HO). Fees invoiced in the early part of 1999 had not been re-charged to Zurich (HO) when the change was made that these would be borne by Zurich (UK), see paragraph 5(21) below. The volume discount was allocated between business units throughout the world. From August 1999 the work was charged in Swiss Francs by PwC AG to Zurich (HO) and on the change to recover this from local business units, re-charged to Zurich (UK) with the discount later being credited against the total. This appeal concerns the VAT treatment of services provided under Work Orders 2 to 10 between October 1999 and December 2000.

(17) In addition about 20 Work Orders were completed from Switzerland for "boot-camp" training in Switzerland of UK staff. The cost of these was borne by Zurich (HO).

(18) Part of the implementation involved an analysis of what the local requirements were, which formed the "as-is" analysis in Work Order 3. For example Mr Warner, head of indirect taxes, was asked by a PwC consultant in January 1999 what features he would like to make his working life easier. He was asked to be bold and creative. His wish to be able to press a button three days before tax returns were due and obtain all the information and a complete audit trail, was not possible, but a meeting was held to explain how the indirect tax team used accounting information to prepare VAT and insurance premium tax returns. A colleague wrote a note of the meeting setting this out. We infer that this was typical of the process.

(19) The implementation of SAP by Zurich (UK) was carried out partly by Zurich (UK) staff (60% of the staff, although originally it had been expected to be 75%) and partly by PwC (UK) (40% of the staff) working as a team in Zurich (UK) premises. At the height there were 165 staff working on the project in the UK.

(20) We infer from the above that Zurich (HO) designed Z-Core in order to provide for its requirement for information prepared on a consistent basis while at the same time enabling it to be configured to meet local requirements. Zurich (UK) required some financial reporting and accounting software, whether the existing OLAS (which was in process of being upgraded) or SAP. It would have needed outside consultancy services to implement any such system. Much of the output from such system would be required by Zurich (UK) even if it were not part of a worldwide organisation. This included its primary accounting needs, management information, and reporting for regulatory purposes, including insurance company regulation and tax. Without such information Zurich (UK) would not have been able to operate.

Change in the funding arrangements

(21) Zurich (HO) funded the worldwide cost of SAP licences. Zurich (UK), in common with other local business units, bore the cost of their own staff involved in the project, and also the cost of any new hardware. It was originally envisaged that Zurich (HO) would bear the entire cost of PwC AG's services without re-charging any of it to other business units. However, at the Group Executive Board meeting on 21 September 1999 it was decided that the cost of PwC's services would be re-charged to the business unit where they were used with retrospective effect from 1 January 1999 as central funding was "not [a] tax efficient use of capital and could be an expensive mistake." Working papers demonstrated a net worldwide tax saving in 1999, taking both direct and indirect tax into account, comprising savings in some countries and increased costs in others, of US $18m of which the UK contributed US $6.5m to the saving on the basis of the invoicing described below. In calculating the UK element of this, a comparison was made between first, the original basis of PwC UK invoicing Zurich (UK) which re-charged it to Zurich (HO); secondly, PwC AG invoicing Zurich (UK); and thirdly, the most tax-effective route, of PwC AG invoicing Zurich (HO) which re-charged Zurich (UK). Although not the subject of evidence, the schedule stated in relation to the third routes that the Swiss input tax was recovered by Zurich (HO) by attributing it to the re-charge to Zurich (UK) and accordingly no Swiss VAT was ultimately borne on this supply. We said during the hearing that we would treat this Swiss VAT treatment as a fact unless the Appellant showed otherwise, which it did not.

(22) The invoicing arrangement that was adopted for the supplies the subject of this appeal followed the third route, that PwC (UK) invoiced PwC AG for their services (zero-rated for VAT by virtue of article 9(2)(e) of the Sixth Directive as consultancy services). PwC AG invoiced "Zurich Leben" (whose full name is Zurich Lebensversicherungs-Gesellschaft, which we understand is a member of the Swiss VAT Group), which we shall treat as the equivalent of invoicing Zurich (HO), by two separate invoices both including Swiss VAT at 7.5%, one for 79% of the total which was re-charged internally by Zurich (HO) to Zurich (UK); and another for 21% of the total which was initially re-charged internally by Zurich (HO) to Zurich (UK) and then recharged by Zurich (UK) to Group life companies in the UK within the UK VAT group on the basis that this proportion of the work for the non-life business was of benefit to the life companies. A reverse charge to UK VAT was paid on the 21%.

(23) Zurich (UK) claimed and obtained capital allowances for corporation tax on the amount re-charged to it totalling £16.7m representing in correspondence with the Inland Revenue that they were "costs incurred for the purposes of the Branch."

6. Article 9 of the Sixth Directive provides:

"1 The place where a service is supplied shall be deemed to be the place where the supplier has established his business or has a fixed establishment from which the service is supplied or, in the absence of such a place of business or fixed establishment, the place where he has his permanent address or usually resides.

2 However:…

(e) the place where the following services are supplied when performed for customers established outside the Community or for taxable persons established in the Community but not in the same country as the supplier, shall be the place where the customer has established his business or has a fixed establishment to which the service is supplied or, in the absence of such a place, the place where he has his permanent address or usually resides:

…

— services of consultants, engineers, consultancy bureaux, lawyers, accountants and other similar services, as well as data processing and the supplying of information,….

3 In order to avoid double taxation, non-taxation or the distortion of competition the Member States may, with regard to the supply of services referred to in 2 (e) [and the hiring out of forms of transport] consider:

(a) the place of supply of services, which under this Article would be situated within the territory of the country, as being situated outside the Community where the effective use and enjoyment of the services take place outside the Community;

(b) the place of supply of services, which under this Article would be situated outside the Community, as being within the territory of the country where the effective use and enjoyment of the services take place within the territory of the country."

The relevant part is article 9(2)(e). We have included article 9(1) since this is relevant to the cases we consider. The issue is whether PwC AG's services, which it is common ground are consultancy services, were supplied at the place where the customer [the Appellant Company] has established [its] business [Zurich (HO) in Switzerland], or the place where it has a fixed establishment to which the service is supplied [Zurich (UK) in the UK]. It is common ground that we should decide the case on the basis of the Directive alone without regard to the VAT Act 1994.

Contentions of the parties

7. Mrs Hamilton and Mr Vallat for the Appellant contend:

(1) That the priority given in Berkholz to the place where the supplier has established his business should be applied in the mirror image case in relation to the place of the customer.

(2) Determining the place of supply at Zurich (HO) did not give an irrational result. Zurich (HO) originally intended to bear the cost of PwC consultancy. There was no conflict between Member States. There was no question of the Appellant Company becoming established in Switzerland to avoid tax.

(3) Determing the fixed establishment as the place of supply would result in both Swiss and UK VAT being imposed. It was not relevant that Swiss VAT was in fact recovered. The places of establishment and fixed establishment in article 9(2)(e) were in contrast to the "use and enjoyment" test in article 9(3).

(4) The actual economic situation should take into account that the Project was part of the global implementation of SAP worldwide; the services while carried out in the UK were for the benefit of both Zurich (HO) and Zurich (UK); that the services built upon Z-Core that had been developed by PwC AG; the objective of the services was to ensure world-wide consistency in reporting; there was close control by Zurich (HO) which had originally intended to fund the whole services.

8. Mr Pleming and Mr Robb, for Customs, contend:

(1) All the services were carried out at Zurich (UK). They were performed for Zurich (UK) and the cost was borne by Zurich (UK).

(2) The objective function of the SAP system was to report the results of Zurich (UK) whether in a form required by Zurich (HO) or Zurich (UK) without which Zurich (UK) could not operate.

(3) The rationality test in Berkholz should be applied by determining the place where they were a cost component, Zurich (UK). Payment of VAT outside the Community was irrelevant to whether the result was rational.

(4) Distortion of competition was demonstrated by the change in the payment arrangements that was made for tax purposes (including both corporation tax and VAT). If the Appellant were right no VAT would be paid anywhere in the chain of formal supply from PwC (UK) to PwC AG to Zurich (HO) to Zurich (UK).

(5) The actual economic situation looked to the opposite of legalistic tests such as invoicing and payment.

9. In reply Mrs Hamilton contended that the cost component test was about attributing inputs to particular outputs, as in BLP Case C-4/94 [1995] ECR I-983, not for the identification of the place of supply in article 9(2)(e).

Reasons for our decision

10. Article 9 has been considered by the European Court of Justice in a number of cases, the first of which is Berkholz (Case 168/84) [1985] ECR 2251 which concerned gaming machines on board ships plying between Germany and Denmark of which the takings were as to 35% received while in German territorial waters and as to the remainder while on the high seas or in Danish waters. The German tax authority contended for VAT on the whole, which was supported by the Danish tax authority which taxed the whole of the equivalent takings of ships flying the Danish flag; the Appellant, supported by the Commission, contended for no taxation in respect of the proportion on the high seas. The issue was whether the place of supply under article 9(1) was where the company was established (Germany) or where it had a fixed establishment (on the ship). The opinion of the Advocate General (Mancini) was that the ship was a fixed establishment; that locating the supply at the fixed establishment was to be preferred as being the place of consumption; and that "irrespective of the State in which the undertaking's principal place of business is situated, will be subject to the law of the State of the ship," which appears to mean that, at least for supplies on the high seas, German VAT was payable, but that presumably Danish tax was payable when the ship was in Danish waters because it would then be a fixed establishment situated in Denmark. The Court agreed so far as supplies made while the ship was on the high seas:

"16….Contrary to the view of the applicant in the main proceedings, supported by the Commission, the Sixth Directive by no means requires services supplied on the high seas, or, more generally, outside the sovereign territory of the State having jurisdiction over the vessel, to be exempted from tax irrespective of the place where those services are deemed to be supplied—the place where the supplier has established his business or some other fixed establishment.

The court first considered the objective of article 9:

14….As the seventh recital in the preamble implies, Article 9 is designed to secure the rational delimitation of the respective areas covered by national value-added tax rules by determining in a uniform manner the place where services are deemed to be provided for tax purposes. Article 9(2) sets out a number of specific instances of places where certain services are deemed to be supplied, whilst Article 9(1) lays down the general rule on the matter. The object of those provisions is to avoid, first, conflicts of jurisdiction, which may result in double taxation, and secondly non-taxation, as Article 9(3) indicates, albeit only as regards specific situations."

The Court then went on to make the point about article 9(1) creating a hierarchy between the place the business is established and the fixed establishment (to which we shall refer as the Berkholz hierarchy):

17. Equally, it is for the tax authorities in each Member State to determine from the range of options set forth in the directive which point of reference is most appropriate to determine tax jurisdiction over a given service. According to Article 9(1), the place where the supplier has established his business is a primary point of reference inasmuch as regard is to be had to another establishment from which the services are supplied only if the reference to the place where the supplier has established his business does not lead to a rational result for tax purposes or creates a conflict with another Member State.

18 It appears from the context of the concepts employed in Article 9 and from its aim, as stated above, that services cannot be deemed to be supplied at an establishment other than the place where the supplier has established his business unless that establishment is of a certain minimum size and both the human and technical resources necessary for the provision of the services are permanently present. It does not appear that the installation on board a sea-going ship of gaming machines, which are maintained intermittently, is capable of constituting such an establishment, especially if tax may appropriately be charged at the place where the operator of the machines has his permanent business establishment.

19 The Finanzgericht's first question should therefore be answered as follows: Article 9(1) of the Sixth Council Directive of 17 May 1977 must be interpreted as meaning that an installation for carrying on a commercial activity, such as the operation of gaming machines, on board a ship sailing on the high seas outside the national territory may be regarded as a fixed establishment within the meaning of that provision only if the establishment entails the permanent presence of both the human and technical resources necessary for the provision of those services and it is not appropriate to deem those services to have been provided at the place where the supplier has established his business."

11. The Court based the Berkholz hierarchy on the context of article 9 and its aim as set out in paragraph 14. We understand by this that article 9(1) is the general rule and the whole of article 9 is to avoid conflicts of jurisdiction resulting in double or no taxation. The Court was faced with an establishment that was on the borderline of being a fixed establishment which had the probable effect, if that were used as the place of supply, of causing a conflict of jurisdiction when the ship was in Danish waters. It concluded that the gaming machines without any human resources was not sufficient to create a fixed establishment so long as tax was appropriately charged at the place where the business was established. The gaming machine company established in Germany would charge the whole receipts to German tax and similarly with a Danish company, which was what happened in practice, at least if the gaming machine company was established in the same country as the flag of the ship. In other words, the Court was not striving to find a fixed establishment in circumstances where the place where the business was established gave an appropriate charge to tax. One suspects that in a case where there was undoubtedly a fixed establishment the Court would not have applied a hierarchy but would have applied the plain words of article 9(1) that the place of supply was the fixed establishment if this is the place "from which the service is supplied."
12. The Berkholz hierarchy has been referred to in other cases where the court found that there was no fixed establishment, see Faaborg-Gelting Linien Case C-231/94 [1996] STC 774, 783 (where again the restaurant on the ship was held not to be a fixed establishment), by the Advocate General (Fennelly) in Maatschap MJM Linthorst, KGP Pouwels en J Scheres (Case C-167/95) [1997] STC 1287, 1297 (although the case is about whether article 9(1) or 9(2) applied), and ARO Lease BV Case C-190/95 [1997] STC 1272 in which the Advocate General (Fennelly) noted that the Court did not intend to limit the Berkholz principle to the facts of the case (paragraph 28). The Court stated (in paragraph 16):

"Consequently, in order to be treated, by way of derogation from the primary criterion of the main place of business, as the place where a taxable person provides services, an establishment must possess a sufficient degree of permanence and a structure adequate, in terms of human and technical resources, to supply the services in question on an independent basis.

This seems to link the use of fixed establishment as the place of supply with the definition of fixed establishment. It appears to say that there has to be a real fixed establishment to move the place of supply from the place of establishment.

13. It is interesting to compare the Court's approach in DFDS Case C-260/95) [1979] STC 384 where it did find that there was a fixed establishment, although the case did not concern article 9(1) but virtually the same wording in article 26 relating to the special scheme for travel agents: "It shall be taxable in the Member State in which the travel agent has established his business or has a fixed establishment from which the travel agent has provided the services," but without any equivalent to article 9(3). The issue was whether the place of supply of package tours was at the Danish place of establishment (where they were exempt) or the fixed establishment in the UK consisting of a sales agent in the form of a wholly-owned subsidiary which was the only contact with the client in relation to the supply. The subsidiary made bookings via a computer link to the Danish parent company and issued travel documentation to the customer in the name of the Danish company without taking any financial risk. It was prohibited from acting for other principals and had extremely limited discretion in pricing. The Advocate General (La Pergola) started by examining "the substance of the case" (paragraph 18) and found that there was a fixed establishment in the UK, the subsidiary being an auxiliary organ forming part of the Danish company. He repeated the Berkholz hierarchy and continued:

29. …Thus, in the present case, attention must be focused on the consequences that would flow from the general criterion of the place where the supplier has established his business. If the result is rational, as intended by the directive, that is the rule to be preferred. There is no need for the other, which concerns the place of the fixed establishment.

30. The United Kingdom government is in favour of following the approach taken by the Advocate General (Mancini) in his opinion in Berkholz and resolving the problem by reference to the general principles laid down in Community tax legislation (see para 24 of the United Kingdom observations). The reference is to para 2 of the opinion at 2255) who, having raised the question of which of the two main criteria in art 9 was to prevail where the place where the supplier has established his business and the fixed establishment did not coincide, gave the following answer: 'The provision is silent in that regard; nor does the preamble to the directive provide any assistance … I therefore propose to rely on the general principle that value added tax should be charged at the place of consumption and hence give preference to the criterion which enables the supply of services to be located more accurately. There is no doubt that the more appropriate of the two for that purpose is the criterion of the "fixed establishment", which is clearly more precise [emphasis added]'. They include the requirement that VAT be levied at the place where the service is provided. That said, and having regard also to the relationship between the English company and its parent, the United Kingdom government infers that the English company is a secondary establishment of the Danish company. The latter is therefore, in its view, taxable in the United Kingdom in respect of the services provided from Harwich.

31. The solution contended for by the Danish company is the opposite one: recourse to the criterion of the registered office is far from irrational or unjustified. In contrast, the criterion of the fixed establishment would lead to confusion, conflicts of jurisdiction and unnecessary complications in the operation of the VAT system (see para 21 of the Danish company's observations).

32. I feel, for the reasons given below, able to align myself with the view advanced by the United Kingdom government. I am also of the opinion that reference to the place where the supplier has established his business does not in this case lead to a rational result. The first consequence of such an approach would in fact be failure to apply the legislative criterion that the place of taxation must fundamentally coincide with that at which the service is supplied to the consumer. That is the basic criterion: the VAT system must be applied in a manner as far as possible in harmony with the actual economic situation. I do not consider it logical for the subsidiary criterion, when the possibility of applying it is assessed, to be automatically treated as being subordinate to that of the place where the supplier has established his business.

33. Furthermore, application of the latter criterion, as advocated by the Danish company, would exacerbate the problems in this case, rather than simplifying them. What would happen if undertakings in the sector were allowed freely to determine, by choosing the location of their registered office, the place at which the services provided by them were to be taxed? There would be distortion of freedom of competition and other, more wide-ranging repercussions for the business world. Article 28(3)(g) gives member states the power to grant exemptions and it is not difficult to imagine that undertakings might choose to establish their registered office in the territory of a member state which has made use of that power. Denmark has done so. To accept the criterion of the registered office in such a case results in distortion of competition between undertakings operating in the same market. In this case, tour operators in the United Kingdom would be discriminated against for establishing their headquarters in one place rather than another. Some of them would be subject to VAT on the services provided by them and others would not.

His opinion that the place of supply was at the place of the fixed establishment was based on the principle that taxation should coincide with the place of supply to the consumer applied in harmony with the actual economic situation (paragraph 32). He regarded the Danish Government's argument in favour of the place of establishment as erring towards formalism, saying that "It fails to take account of the fact that the economic realities of this case justify making travel agency business subject to VAT at the place where the services are provided" (paragraph 35). He was therefore regarding travel services as provided where the contract for them was made rather than where the underlying supply was made.

14. The Court repeated the Berkholz hierarchy but emphasised the need for a fixed establishment to have a certain minimum size in order to qualify as a fixed establishment (paragraphs 20 and 28). It decided that the UK subsidiary was an auxiliary organ of the parent company and was a fixed establishment and approved the Advocate General's reliance on the actual economic situation:

20. Moreover, services cannot be deemed to be supplied at an establishment other than the place where the supplier has established his business unless that establishment is of a certain minimum size and both the human and technical resources necessary for the provision of the services are permanently present (see Berkholz (at 2263, para 18)

21. In this case, to treat, for tax purposes, all the services provided by a tour operator, including those supplied in other member states through undertakings operating on his behalf, as being supplied from the place where the tour operator has established his business, would have the clear advantage, as the Danish company has pointed out, of having a single place of taxation for all the business of that operator covered by art 26 of the Sixth Directive.

22. However, as the United Kingdom government has pointed out, that treatment would not lead to a rational result for tax purposes in that it takes no account of the actual place where the tours are marketed which, whatever the customer's destination, the national authorities have good reason to take into consideration as the most appropriate point of reference.

23. As the Advocate General points out in paras 32 to 34 of his opinion, consideration of the actual economic situation is a fundamental criterion for the application of the common VAT system. The alternative approach for determining the place of taxation of the services of travel agents, based on the fixed establishment from which these services are supplied, is specifically intended to take account of the possible diversification of travel agents' activities in different places within the Community. Systematic reliance on the place where the supplier has established his business could in fact lead to distortions of competition, in that it might encourage undertakings trading in one member state to establish their businesses, in order to avoid taxation, in another member state which has availed itself of the possibility of maintaining the VAT exemption for the services in question.

24. In those circumstances, it must be concluded that, where services have been provided by a tour operator from a fixed establishment which that operator has in a member state other than that in which he has established his business, such supply of services to the customer is taxable in the state where that fixed establishment is located.

…

26. The fact, mentioned by the tribunal, that the premises of the English subsidiary, which has its own legal personality, belong to it and not to the Danish company is not sufficient in itself to establish that the subsidiary is in fact independent from the Danish company. On the contrary, information in the order for reference, in particular the fact that DFDS's subsidiary is wholly owned by it and as to the various contractual obligations imposed on the subsidiary by its parent, shows that the company established in the United Kingdom merely acts as an auxiliary organ of its parent.

28. It is apparent from the facts set out in the order for reference, particularly as regards the number of employees of the company established in the United Kingdom and the actual terms under which it provides services to customers, that that company does display the features of a fixed establishment within the meaning of the above-mentioned provisions."

In English law we would describe the subsidiary as an agent of the parent company (but not an independent agent, for the reasons set out in paragraph 26 of the Judgment). This type of fixed establishment will be recognised as an example of an agency permanent establishment in direct tax, see articles 5(5) and (6) of the OECD Model Tax Convention (in the French version of the Sixth Directive and of the OECD Model the same expression, établissement stable, is used for both fixed establishment and permanent establishment). The result is, however, different since in direct tax probably a sales profit in excess of the sales commission would be taxed in the UK and either the whole profit would be taxed in Denmark with credit for the UK tax, or the remainder of the profit would be taxed in Denmark. For VAT it was the whole of the supply by the Danish company that was taxed in the UK.

15. In the latest case, RAL (Channel Islands) Limited Case C-452/03 the issue was between article 9(1) and 9(2) with the Court deciding that the latter applied. The Advocate General (Maduro) while also giving his opinion in favour of article 9(2) also considered in the alternative the relationship between the article 9(1) criteria of place of establishment and fixed establishment, since he considered that the gaming machines were a fixed establishment in the UK on the ground that there were human resources available although they were employed by another company. He was particularly influenced by the place of establishment being outside the Community:

63. As to the present case, in their written observations both the United Kingdom Government and the Commission consider that the result of the application of the connecting factor of the place of business would be that the slot-gaming machine services provided in the United Kingdom to consumers resident there would not be taxed at all, either in the United Kingdom or in any other Member State. The reasoning in DFDS should therefore be followed a fortiori in the present case because here VAT cannot be charged, purely and simply, at the place where the operator of the machines (CI) has its place of business (Guernsey).

64. I agree….

Thus the Advocate General considered there to be a fixed establishment and he was influenced by the fact that the place where the supplier had established his business was outside the Community. The Court did not consider article 9(1) as it found the supply to be within article 9(2)(c) (entertainment activities).

16. The principle that we derive from these cases is that although the Court has often repeated the Berkholz hierarchy it has never used it as the deciding factor when there was undoubtedly a fixed establishment. DFDS is the only case where the Court found that there was a fixed establishment with a substantial presence and on the facts that establishment was determined to be the place of supply. It is interesting that the result, based on considering the actual economic situation, was that the entire supply (being the supply of a single service, see article 26(2)) made by the Danish company for which it received 81% of the consideration in Denmark was located at the fixed estabishment in the UK, where there was merely an agent receiving a commission of 19% and taking no financial risk, and probably no part of the travel took place in the UK. The Court was therefore applying the economic situation not to the underlying supply of travel services but to determining whether there was "a fixed establishment from which the service is supplied." In other words, the place from which the supply of the single travel service was made was determined by where the contract was made, the documentation issued, and the consideration paid. The Advocate General determined the supply to have been made by the fixed establishment in RAL on the alternative basis that article 9(2) did not apply, which the Court did not need to deal with as it decided in favour of article 9(2) applying. Moses J in Customs and Excise Commissioners v Chinese Channel (Hong Kong) [1998] STC 347 found the same difficulty in analysing the cases (although the point did not arise for decision as he decided that the Tribunal's decision that the supply was made from abroad could not be upset). He said:

"No one has yet succeeded in persuading the Court of Justice that the fixed establishment test should predominate. The cynic might observe, however, that in every case where the court has emphasised the priority of the main place of business test, the court also found that no fixed establishment existed. It remains to be seen what the court would decide to be the appropriate test where they find that there was a fixed establishment from which the supply was provided."

It is puzzling that he did not include DFDS as a case where the fixed establishment predominated. It seems to us that the European Court has relied on the hierarchy in cases where it was doubtful whether there was a fixed establishment, but where, as in DFDS, there undoubtedly was a fixed establishment it did not give much weight to it. The court decided the issue in DFDS by considering the consequences of each possibility based on economic realities (as the Advocate General put it in RAL, "an analysis that is especially responsive to the factual economic and commercial reality of the case" (paragraph 44)), and taking into consideration that using the place of establishment might encourage the relocation of that place in a member state which exempted the service (DFDS) or outside the Community (the Advocate General in RAL). Accordingly, since in this appeal there is no doubt about the existence of a fixed establishment with many thousands of employees there, we shall apply the same approach based on economic reality, rather than apply a hierarchy.

17. We remind ourselves of the test to be applied. Article 9(1) dealing with the place of supply is a deeming provision: "the place where a service is supplied shall be deemed to be the place where the supplier has established his business or has a fixed establishment from which the service is supplied." For article 9(2)(e) services, the deeming looks to the customer rather than the supplier: "the place where the customer has established his business or has a fixed establishment to which the service is supplied." The existence of article 9(3) giving Member States an option (not taken up by the UK) of using a test of "where the effective use and enjoyment of the services takes place" demonstrates that this is a different test from the identification of the customer in the two alternatives in article 9(2)(e), although, of course, it does not mean that the result of the two tests cannot be the same. But it does suggest that the question is not answered primarily by identifying the place where the supply is effectively used and enjoyed. We must chose between the two possibilities on the basis of rationality, economic reality and distortion of competition.
18. We start by considering the facts in terms of economic reality. One aspect of economic reality is that we can look at the two establishments as if they are two separate persons, while, of course, recognising that legally they are establishments of a single person. Indeed the concept of a "fixed establishment to which the service is supplied" almost requires one to treat the fixed establishment as if it were a separate person. The actual economic result does not, we consider, require us to ignore what Mr Pleming would have us class as legalities, such as the place of contracting and invoicing. Rather, we should consider whether there is an economic rationale for the place where they occur.
19. We consider first the place of contracting. The services were supplies pursuant to (1) the framework agreement which was negotiated and completed in Switzerland between two Swiss parties long before Zurich (UK) came on the scene, and (2) the Work Orders made between the same parties but which were negotiated between Zurich (UK) and PwC (UK) and only concluded when Zurich (HO) approved and signed them and PwC AG signed them. There is no suggestion that approval of the Work Orders by Zurich (HO) was anything but genuine. When the Work Orders were completed and became contractual documents it was envisaged that the entire cost would be borne by Zurich (HO) which had a direct interest in the terms of the Work Orders. In addition, Zurich (HO) kept close control of the entire project through Mr Bottome's committee structure which received information weekly (including in a weekly telephone conference call) and monthly from the UK (and other business units), and through Mr Bottome's testing Z-Core by remote access. There was economic reality in Zurich (HO) doing this because it required the worldwide implementation of SAP and had an interest in the financial reports that it produced.
20. Which location bore the cost? Although it was envisaged that Zurich (HO) would bear the cost when the Work Orders were finalised in August 1999 this was changed in September 1999 so that Zurich (UK) bore the whole of it.
21. Next we consider what was done. Employees of PwC (UK) were working in Zurich (UK) premises as part of a team, which also comprised Zurich (UK) employees, under the direction of Mrs Stringer, an employee of Zurich (UK), as project director. The team were working (as to 65%) on the interface hub changing the format of the files produced by Zurich (UK)'s accounting systems into the required SAP format, but PwC's input would be less than this percentage because it was the Zurich (UK) employees who were familiar with the existing systems. Secondly, they were modifying Z-Core to produce results in the form required for UK purposes, principally regulation. A higher proportion of this work was done by PwC (UK) employees because they had the expertise on SAP. All of this was carried out in the UK.
22. Finally, for the benefit of which establishment was the work done? We consider that it was both. The subject matter of the work was the financial results of Zurich (UK) which Zurich (UK) needed for its own regulatory reporting and without which it could not operate. Zurich (HO) were also interested in the results of Zurich (UK) so that it could report the worldwide results and had produced Z-Core in order to receive reports in a form it required. Z-Core only worked if the input from the UK accounting systems was in the right format.
23. Weighing up these factors in terms of economic reality as understood in DFDS we regard the place of contracting as the most important. We pay less regard to the work being done in the UK because the question is not where did the supply take place (as it is for article 9(2) supplies) but who is the customer. Similarly, in DFDS where the travel took place was not a consideration. We regard the place of benefit as the least important, particularly as neither location received the benefit to the exclusion of the other. If payment for the services had been borne by Zurich (HO) as originally proposed we would regard it as clear that the service was supplied to Zurich (HO). If Zurich (HO) and Zurich (UK) were two different legal persons, these factors would certainly point to Zurich (HO) as the contracting party and the place of contracting and payment, the factor that was given importance in DFDS, however much Zurich (UK) benefited from the service. It would be analogous to the supply by the estate agent in Customs and Excise Commissioners v Redrow [1999] STC 161. But this was changed so that Zurich (UK) bore the costs which points away from Zurich (HO) being the notional contracting party. Does it mean that we should pay less attention to the "calling the shots" factor and treat the service as supplied to Zurich (UK) when the factor of the work being done in the UK is added? We do not think it does. First, Zurich (HO) as notional contracting party remains such because PwC AG looks to it for payment. The bearing of the expense by Zurich (UK) is a subsequent notional contract which is of no concern to PwC AG. Secondly, the change to Zurich (UK) bearing the cost was made for tax reasons, which means we give it less importance in applying economic and commercial reality, but not to the extent of disregarding it. Our tentative conclusion is therefore that the supply was made to Zurich (HO).
24. Having reached such conclusion we test it for rationality and distortion of competition. Mr Pleming contends that it is irrational that there is non-taxation if there is consumption within the Community. The example about irrationality given by the Advocate General in DFDS was based on companies establishing themselves in a country where the supply was exempt, which on the assumption that there was a fixed establishment in RAL was also applied to companies establishing themselves outside the Community. This example in DFDS was given in the context of article 26 which has no equivalent of article 9(3) enabling Member States to apply an effective use and enjoyment test, which could be applied here (and in RAL) but the UK does not do so. We do not consider that one can use this argument to determine that the services were supplied to Zurich (UK) when on the approach in DFDS the supply was made to Zurich (HO). The reason why there is no tax in the UK is that there is no tax on the transfer of the services between a head office and a branch (compare the charge in article 28a(5)(b) on the acquisition and supply of goods within the Community in such circumstances).
25. We are not persuaded by Mr Pleming's cost component argument as part of the test of rationality. We do not consider that the existing authorities support the use of it to determine the place of supply, as opposed to the attribution of inputs to outputs, as in BLP. One of the problems is that the PwC services with which we are concerned are part of a worldwide overhead cost which only makes sense if SAP is implemented worldwide. Part of the cost was borne by Zurich (UK) but other parts, such as the SAP licenses and the development of Z-Core, were borne by Zurich (HO). One cannot identify any outputs with the PwC services with which we are concerned. The most that can be said is that the cost fell on Zurich (UK) and had to be met out of profits generated in the UK. Although we shall not use this argument, the place where the cost was borne is one of the facts that we have taken into account.
26. Nor do we see any relevance in the direct tax treatment, under which first, "there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment" and secondly, a deduction is allowed for "expenses which are incurred for the purposes of the permanent establishment…whether in the State in which the permanent establishment is situated or elsewhere" (UK-Swiss double taxation agreement articles 7(2) and (3)). The assertion that PwC AG's fees were "costs incurred for the purposes of the Branch" makes sense in the light of this. The issue is very different from whether the branch is a fixed establishment to which the service is supplied.
27. Accordingly, following from our analogy of the two establishments being two separate parties, we consider that the supply in question was made to Zurich (HO), and that Zurich (UK) is not "a fixed establishment to which the service is supplied." We decide that Switzerland is the place of supply.
28. Mrs Hamilton included two alternative arguments in her skeleton: that PwC UK was acting as an auxiliary organ of PwC AG so was a fixed establishment of PwC AG in the UK with the result that the supply was made in the UK, or that the supply was made by PwC UK. This was objected to by Mr Pleming on the ground that it had not been raised before and no application had been made to amend the grounds of appeal. It was, he contended, prejudicial to Customs as they are out of time from collecting tax from PwC UK and it would be necessary to join PwC AG in order for the issue to bind them. We decided that we would postpone dealing with these points until we had made our decision on the main ground. Since we have found for the Appellant there is no need for us to hear argument on these points. However, should our decision be reversed on appeal we merely note that we have made no decision on whether they can be raised.
29. Accordingly we allow the appeal in principle. If the figures cannot be agreed either party may give notice to the Tribunal Centre requiring us to determine them. We direct the Respondent to pay the Appellant's costs of and incidental to and consequent upon the appeal to be assessed in default of agreement by a Taxing Master of the Supreme Court of Justice in England and Wales by way of detailed assessment on the standard basis.

JOHN F AVERY JONES

CHAIRMAN

RELEASE DATE: 30 June 2005

LON/02/1080