Foreign on-site services – Fixed places of business?
Foreign business activities – in particular providing on-site legal services – give rise to the question, whether this can trigger an income tax liability in the countries where those services are performed.
According to German domestic law, self-employment services performed by a non-resident locally are subject to German income tax, Sec. 49 Para. 1 No. 3 German Income Tax Act (ITA). The same applies to all partners of a partnership where services are performed locally by the partnerships, i.e. by employees and/or partners of the partnership, while the resulting income is attributed to all partners.
However, OECD based tax treaties require a fixed place of business or a permanent establishment used for business activities in order to provide taxation rights regarding self-employment income in the country of source. This can be the case, if foreign on-site business facilities are at the disposal of a law firm, for example office-spaces, and business activities are carried out there. However, the "mere presence of an enterprise at a particular location does not necessarily mean that that location is at the disposal of that enterprise" (OECD Commentary, art. 5 rec. 4.2).
In this context, the German Federal Fiscal Court (BFH) recently decided the case of a referee, who was regularly acting as a referee of international football (soccer) matches in different countries (case number I R 98/15). The BFH specified that acting as a referee of matches itself did not suffice for permanent establishments in those countries and that "referee cabins" for the use of the referee locally did not constitute fixed places of business, since they were only used very temporarily. Irrespective of any disposal rights the place was not a fixed place due to short term of usage. In this respect the BFH referred to the painter example of the OECD Commentary on Art. 5. It should be noted, that even if the place of business was fixed due to a long-term usage, Germany and the BFH have a strict view in the interpretation of OECD based tax treaties and require some sort of authority to dispose of a fixed place to constitute a permanent establishment.
From a law firm perspective, using offices at a client's local company is somewhat comparable to the temporary use of referee cabins and should, if short term, not trigger a fixed place of business. However, if the usage is lasting for a longer period the outcome could be other, but there are unfortunately no strict guidelines as to when a "temporal" use becomes a "sufficient" use and constitutes a fixed place. Furthermore, there would have to be a sort of disposal right to qualify as a permanent establishment. The latter might easily be the case if office space is used for a longer period, e.g. for investigations, and physical files, which should only be available for the law firm, are stored in the used office space.
In general, taxpayers can deduct expenses related to their income. This also includes expenses for a second household at the place of work. According to Sec. 9 Para. 1 No. 5 Sentence 4 ITA, respective expenses are only deductible up to 1.000 Euros per month.
In its recent decision, the BFH (file number VI R 42/15) has specified the deductibility. Only expenses for an "average apartment", average relating to both "furnishing" and "location", are tax deductible. The BFH ruled that only apartments with a living space of up to 60 square meters may fall into that category. To the extent tax deductible the taxpayer might receive a tax-free equalisation from the employer. Thus, employer benefits for a secondary home are only tax-free if and to the extent they are within that "average" scale. The BFH referred to the official German rent index to determine the average rent for a secondary home. Any benefits in excess such as equalisation payments or the provision of apartments which are above average result in taxable wage and are subject to wage tax.
Company cars could result in tax benefits for the employee even if expenses are borne by the employer. This impact may arise due to a lump sum determination of benefits of company cars. However, the lumpsum determination of benefits for private purposes is only applicable if the company car is economically owned by the employer.
A company car may be qualified as an employee's own car for tax purposes if the employee has the car at his disposal "like an owner". Sub-lease agreements in particular may lead to the attribution of a company car to the employee, thus excluding the application of the desired tax regime. This may even be the case without written agreements. It is decisive whether or not the employee him- or herself is de facto required to pay the instalments and carries the risk of damage or loss of the vehicle. (For further information see BFH, file number VI R 75/13).
It should also be noted, that if co-entrepreneurial partners shall benefit from company car tax rules, the rules are similar but in some respects even more complex.
When submitting a recapitulative statement due to Value Added Tax requirements, law firms may be obliged to disclose their clients. While client information is – in principle – privileged, Sec. 18a of the German Value Added Tax Act (VAT Act) requires the entrepreneur as a service provider to quarterly state, amongst other things, the individual VAT number of each foreign service recipient, as well as the total amount of fees invoiced to each recipient for intra-Community services (meaning services provided within the European Union).
This duty of documentation towards the tax authorities also applies to law firms and their clients, as the BFH decided in September 2017 (file number XI R 15/15). Thus, the declaration of intra-community services without an allocation to individual VAT numbers, according to Sec. 18b of the VAT Act, can be insufficient.
Sec. 18a, as a more extensive documentation standard of the VAT Act, the BFH specified, applies at least in cases where clients have given their individual VAT number to the law firm. Even though Sec. 102 of the German Fiscal Code gives "solicitors [...] tax consultants" and members of other professions the right to withhold client information even in a fiscal context, clients release their legal counsel from the secrecy obligation by implication when providing them with their VAT number, the BFH concluded.
The decision also indicates that it may be possible to interpret Sec. 18a of the VAT Act as an overriding principle that suspends the right to withhold client information. This was, however, not relevant to the specific decision.
Law firms should be aware of their obligation to submit a recapitulative statement, including the VAT numbers and related billing information of those clients, who disclosed their VAT number to the firm. Disclosing this documentation duty to each client affected is, however, recommendable.
With respect to a pending case (file number V R 51/16), the BFH has presented several VAT-related issues to the European Court of Justice, concerning the question when VAT is due. Firstly, the BFH asks whether European Law dictates that the tax claim may already be due and payable, when also the underlying contractual claim for (goods or) services provided is generated. The BFH doubts, whether the taxpayer should be obliged to pre-finance high amounts of VAT without collecting payments for the underlying transactions that are subject to VAT. The BFH argues, that – at least – hardship provisions may be necessary, if, for example, a service provider would have to pre-finance tax payments for more than two years. This might be a relevant question in the case of long payment terms or late invoicing.
The BFH also asks, if an unequal treatment of taxpayers, depending on whether they can file VAT returns on a cash or accruals base is justified. Currently, the due dates for tax payments can differ significantly between businesses that follow the cash method and businesses that follow the accruals method. Some law firms may be able to opt to the cash method while others cannot, depending on obligatory local or voluntarily book keeping and balance sheet preparations. We recommend to observe the development of the case. The decision of the European Court of Justice could have a strong influence on the application and future design of German VAT regulations.
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