The Preliminary Ruling on Issues Relating to International Taxation – EU Law
At the end of 2015, the European Court of Justice of the European Communities (ECJ) released its preliminary ruling on the case entitled WebMindLicences EUECJ C-419/14. The case concerned the Value added tax (VAT) and the abuse thereof. Specifically, it concerned whether licensing agreements were abusive for VAT purposes. This ruling provides helpful guidance on the relevant factors to take into consideration when determining if an arrangement of business or services provided amounts to abuse.
As background, WebMind Licenses is a commercial company that is based out of Hungary. WebMind licensed a website and knowhow rights to a Portuguese company called Lalib. Within this licensing agreement, WebMind remained responsible for ongoing maintenance and development of the software involved.
Following an audit that culminated in 2013, WebMind was assessed to Hungarian VAT on the basis that the licensing agreement was an artificial and not a genuine economic transaction. The Hungarian tax authorities determined that this transaction was not genuine and was exploited by WebMind. The Hungarian tax authorities gave WebMind a large tax bill because they believed the tax should have been paid in Hungary, not in Portugal. The supplies, in fact, were made by WebMind in Hungary, rather than by Lalib in Portugal.
This was considered abuse of rights by giving the impression that it was based in Portugal in order to avoid Hungarian tax law, which would give them a lower tax rate in Portugal. WebMind fought back by bringing an action against the Hungarian tax authorities. The case made its way to the ECJ to determine whether an abuse of rights has occurred, and further interpretation of the doctrine.
Numerous questions were asked of the ECJ in this case. The ECJ considered all of the questions and made its preliminary ruling.
The ECJ determined that within similar circumstances, a licensing agreement concerning the availability of know-how enabling operations of a website by which audiovisual services were supplied, where a company established in a Member State other than in which the company granting the license is established, did arise from an abuse of rights.
In order to establish such a conclusion, the ECJ determined that it must be established that the agreement constitutes a wholly artificial arrangement. This was due to the fact that the rate of value added tax applicable to those services was lower in that other Member State, in this case Portugal, and combined with the fact that the manager and sole shareholder of the latter company was the creator of the know-how. This culminated in the same person exercising influence or essentially control of development and exploitation of such know-how and supplied services which were based on it. Essentially, the company granted a license to itself in order to receive lower tax benefits. The ECJ ruled that this is an abuse for VAT purposes.
In clarification, the ECJ confirmed that it is not abusive for a company established in one Member State to enter into a licensing agreement with another company established in a different Member State to exploit the lower VAT rate. The abuse comes in when the arrangements were fictitious. The fact in and of itself that a company established in a Member State which applied a standard rate of VAT lower than that of the Member State in which the company granting the license is established cannot without other factors be regarded as an abusive practice.
In the documents submitted to the court in this particular case, it showed that Lalib was a separate company from WebMind and that it paid VAT in Portugal. The court determined that it was their responsibility to determine whether the facts as a whole demonstrated whether the arrangements were genuine or not. This included the ECJ examining the establishment of the licensee’s place of business and whether that aspect was genuine. It wanted evidence that Lalib had tangible premises, equipment, human and technical resources which overall gave Lalib the ability to engage in economic activities under its own name or on its own behalf, and under its own risk and responsibilities.
The EU law was interpreted to mean that if an abusive practice is found in a situation like this case, the fact that the VAT has been paid in that other Member State (Portugal) does not prevent an adjustment of tax in the Member State (Hungary). This shows that if an abuse has been found, then the company performing the abuse will not get out of paying the correct taxes just because it has already paid tax. The court will find that an adjustment should and will be made to rectify the wrongs done.
Further, the ECJ considered the circumstances to establish abuse for VAT purposes and which would comply with EU law for a tax authority to use any evidence obtained with or without the taxpayer’s knowledge to initiate a parallel criminal proceeding. It was determined that EU law in fact does not preclude tax authorities from using evidence obtained in these circumstances, provided that the rights guaranteed by EU law, including the Charter of Fundamental Rights of the European Union, are taken into consideration.
Within the WebMind case, the tax authorities intercepted communications without judicial authorization. The ECJ sent the case back to the referring court to review whether this was provided for by law and whether it was necessary. Further, the lower court needs to determine whether the taxpayer has the opportunity of gaining access to this evidence and make appropriate representations. The national court will need to determine the relevant factors in this case to determine whether the definition of wholly artificial agreement set out by the ECJ was met.
If the national court finds that WebMind did not have the opportunity of gaining access to the evidence being used against them, it must disregard that evidence.
The case demonstrates the ECJ’s use of the substance over form doctrine to determine whether such transactions are genuine or wholly artificial, and whether the VAT should be treated differently than what was envisioned by the contracts alone. Indirectly, it is increasingly important to take into account all requirements when establishing a business structure or reviewing existing transactions.
With the conclusion of this preliminary ruling, there are mixed feelings about the result. Will it be difficult to determine in the future when a licensee is a wholly artificial arrangement? Perhaps if a company believes they are following this ruling, but then a court interprets that they are not, are they now subject to double taxation? Does this ruling truly outline the definition of wholly artificial arrangement so that companies may avoid violating EU law?
However, this is a very narrow case. It considers a website licensing agreement for audiovisual services. This case could potentially expand to other cases of similar, or even different online services. It is too soon to say whether the ECJ will take this stance.
It is important to note, however, that this sort of arrangement is no longer VAT advantaged since the VAT rate charged on supplies to consumers is not the rate where the consumer is located, nor where the service provider is located. The guidance from this case is still useful though.
In a nutshell, the following circumstances do not appear decisive for the purpose of establishing the abuse of rights:
· The manager and sole shareholder of WebMind was the creator of its know-how, the same person exercised influence or control over the development, utilization of that know-how and supply of services
· The management of the financial transactions, staff and technical resources essential for the supply of those services was carried out by subcontractors
· Economic and financial reasons led WebMind to make the services available to the Portuguese company
So if this information is not enough to demonstrate a wholly artificial agreement, what will it take? The ECJ allowed the national court to make this determination. But it appears to be that the ECJ is looking for more substance, for example, the physical presence of WebMind required in Portugal, in order to determine what is considered a wholly artificial agreement.
This is the explanation that the ECJ is showing. There needs to be more than mere paper explaining that a different company is creating the web service product in order to show a genuine agreement or economic transaction.
ROGER A. STRICKLAND JR
Roger is also an iGaming Expert who has made immense contributions to the Malta iGaming Industry.
He holds an Honours Degree in Management from University of Malta. Amongst his many interests, Roger is also a member of various philanthropic organizations, and the president of his local football club.