Spain Shakes Up Vat Standards: Local Branches Can Be Treated as Separate Taxable Persons Outside a Vat Grouping – Impact on Financial and Insurance Industries
In brief
The Spanish Tax Authorities (STA) have interpreted EU VAT law to argue that internal flows between a head office and its foreign branches may be subject to VAT when the branch is deemed to operate independently. This stance, based on a broad reading of the Court of Justice of the European Union (CJEU) FCE Bank judgment, has been applied even when branches are not part of VAT groupings. Such deemed independence is assessed in practice using financial statements, transfer pricing documentation, capital assigned to the branch and operational autonomy indicators. While initially focused on the financial and insurance sectors, this approach could extend to other industries, though its financial impact may be limited for businesses with full VAT deduction rights.
It is important to note that there is currently no specific legislation or official guidance from the Authorities confirming that a branch constitutes a separate VAT taxpayer. To the best of our knowledge, this interpretation is uniquely held by the STA within the EU.
However, the Spanish Central Administrative Court (TEAC) has upheld this interpretation in repeated cases, so, now this criterion is binding for the administration, despite the possibility of it being turned down by higher courts.
On the other hand, one may argue that the STA’s position misinterprets EU law, contradicts the views of EU institutions, and may violate principles like freedom of establishment. The issue may ultimately reach the CJEU, potentially influencing VAT treatment of flows across the EU. Further developments from Spanish courts are expected.
What is changing?
Since a few years ago, the STA have adopted the position that payments or flows between a head office and its branches – or vice versa − may constitute consideration for VAT-taxable transactions, provided that certain conditions are met (Reflected in at least two assessments issued by the TEAC, being the more recent one the assessment of 18 October 2024 Number 03844/2022).
These internal flows are common practice for allocating income and expenses across jurisdictions to comply with direct taxation and, in particular, Transfer Pricing (TP) principles. For example, if a branch uses IT systems owned by the head office, it should compensate the head office or at least allocate the corresponding income and expense, respectively. These flows are typically pinpointed in the TP documentation.
The STA’s position is based on an unusual interpretation of the FCE Bank (Case C-210/04) judgment by the CJEU and related case law. They argue that such flows may be taxable when the branch operates independently from the head office, thereby treating them as separate VAT taxable persons, in particular when it bears the economic risk arising from its business. However, this interpretation appears to reverse the CJEU’s actual outcome of all the judgments. Besides, they intervened with the fact that a fixed establishment has a certain degree of autonomy to conclude that it is an independent taxable person.
Notably, this approach is applied regardless of whether the branch or head office is part of a local VAT grouping—going beyond the scenarios addressed in the Skandia America (Case C‑7/13) and Danske Bank (C-812/19). The STA target branches both within and outside VAT groupings. In practice and according to our experience, to assess a branch’s deemed independence the STA examine:
- The branch’s financial statements,
- TP documentation, and
- Operational indicators such as client acquisition autonomy, hiring authority, benefits application, procurement approvals, and day-to-day decision making.
- They also consider the capital allocated to the branch to assess its ability to bear its own business risks.
Therefore, it is essential to review and ensure that the documentation accurately reflects the operational reality and clearly demonstrates that the branch does not operate independently.
While the STA have primarily focused on the financial and insurance sectors (which have limited the VAT deduction right, with a huge impact in terms of amount assessments), their approach could potentially extend to all industries. However, for businesses entitled to deduct input VAT, the financial impact may be limited.
Our view
As previously noted, the STA’s interpretation is highly unusual. In our view, it is particularly in question for several reasons, such as:
- The interpretation of EU law and CJEU might not be correct. The approach may violate EU principles of freedom of establishment and non-discrimination (principle of equivalence): Why are internal flows between Spanish branches and head offices not taxed, while cross-border ones are?
- Indeed, to the extent of our knowledge Spain is the only EU Member State to adopt this approach.
- Both the European Commission and the European Parliament[1] have stated that such flows should not be taxed under VAT.
- The Advocate General Kokott has also opined (Case C‑533/22 - Point 35) that these flows are not VAT-able.
- The STA cannot base their conclusions on documents thought to comply with direct taxation principles or the local financial statements.
- It is highly arguable that a branch bears the economic risk arising from its business, as the entity is responsible as a whole, this is by the resources of the head office and all the places where it arranges its activity.
It is noteworthy that there seems to be some confusion within the STA regarding the distinction between having a certain degree of autonomy (requirement of a fixed establishment) and the conclusion that the branch is an independent taxable person.
And even if an independence test is required during audits (if it might be understood so in the light of the FCE Bank judgment), the STA should consider the full context, including whether the branch truly makes independent decisions or bears the risks of its local operations—and typically, it does not.
Next steps
TEAC, which is a part of the tax administration, has upheld the STA’s position in at least two cases. So, now that there are two TEAC rulings with the same criterion, the STA are bound to apply the law accordingly. It is expected that the STA will initiate broader actions in this regard.
The recent TEAC rulings are somewhat underwhelming, as they do not fully explore the legal and factual specifics of each case. They have been probably appealed to the National Court which could potentially elevate them to the CJEU and so could lead to the extension of this interpretation across the EU. After the National Court rules, the case could also be brought before the Supreme Court, which may request a preliminary ruling to the CJEU as well. So, it is expected that the courts will decide further on this topic.
Key takeaways:
- The interpretation significantly raises the VAT exposure for financial and insurance entities operating in Spain through a branch.
- Businesses should anticipate more scrutiny from tax authorities. Now, there are two TEAC rulings and the STA are required to apply its criterion.
- Operators must prepare and review the supporting documentation and process carried out, so that they will be in a better position to defend.
Our Indirect Tax team at Alvarez & Marsal is ready to help you evaluate your exposure and design a protective VAT strategy. We have also experience in this topic assisting clients during audits and courts.
Related articles:
Judgement C-601/23 of the Court of Justice of the European Union
Asesoramiento en Fiscalidad Indirecta del Reino Unido para Clientes Españoles
[1] On the Proposal for a Council Directive amending Directive 77/388/EEC as regards the place of supply of services (COM(2003) 822 – C5‑0026/2004 – 2003/0329(CNS)).
