VATupdate

Flashback on ECJ Cases – C-165/17 (Morgan Stanley) – VAT deduction by branches rendering services to their head-office

Source Curia

Decision

1.      Article 17(2), (3) and (5) and Article 19(1) of Sixth Council Directive 77/388/EEC of 17 May 1977 on the harmonisation of the laws of the Member States relating to turnover taxes — Common system of value added tax: uniform basis of assessment, and Articles 168, 169 and 173 to 175 of Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax must be interpreted as meaning that, in relation to the expenditure borne by a branch registered in a Member State, which is used, exclusively, both for transactions subject to value added tax and for transactions exempt from that tax, carried out by the principal establishment of that branch established in another Member State, it is necessary to apply a deductible proportion resulting from a fraction the denominator of which is formed by the turnover, exclusive of value added tax, made up of those transactions alone and the numerator of which is formed by the taxed transactions in respect of which value added tax which would also be deductible if they had been carried out in the Member State in which that branch is registered, including where that right to deduct stems from the exercise of an option, effected by that branch, consisting in making the transactions carried out in that State subject to value added tax.

2.      Article 17(2), (3) and (5) and Article 19(1) of Sixth Directive 77/388, and Articles 168, 169 and 173 to 175 of Directive 2006/112 must be interpreted as meaning that, in order to determine the deductible proportion applicable to the general costs of a branch registered in a Member State, which are used for both transactions of that branch in that State and transactions of the principal establishment of that branch established in another Member State, account must be taken, in the denominator of the fraction which makes up that deductible proportion, of the transactions carried out by both that branch and that principal establishment, it being specified that it is necessary that, in the numerator of that fraction, besides the taxed transactions carried out by that branch, solely the taxed transactions carried out by that principal establishment must appear, in respect of which value added tax would also be deductible if they had been carried out in the State in which the branch concerned is registered.

Background

  • Case considers the VAT recovery right for branches which provide services to their head office.
  • Morgan Stanley’s French branch supplied financial services to local customers (those services were taxable as the branch had “opted to tax” its financial supplies).
  • The branch also provided services to its UK head office for which the branch received payments.
  • The branch recovered its VAT in full on the basis that its French supplies were taxable and its branch support activities were disregarded from a French VAT perspective.
  • The French Tax Authorities considered, at first, that the VAT incurred for the purpose of the supplies made by the branch to the head office was not deductible because those supplies fall outside the scope of VAT.
  • The French Court (“Conseil d’Etat”), relying on the CJEU’s ruling in the ESET case (C-393/15) acknowledged that the branch should have a right of deduction of the VAT incurred for the purpose of the support supplies to the head office. However, the “Conseil d’Etat” decided to ask the CJEU to clarify the principles for determining the proportional deduction of the branch.

Judgement

  • CJEU recalled that for VAT to be deductible, the costs incurred must have a direct and immediate link with transactions carried out and giving rise to a right of deduction. In addition, the VAT Directive provides that a taxable person is entitled to deduct input VAT on costs used for transactions carried out abroad, if a right of deduction was available were the same transactions carried out within the country.
  • CJEU held that a branch which incurs VAT in relation to supplies both to its own customers as well as support services to its head office may recover VAT on its costs. Given the mixed activities carried out by the head office (exempt/taxable supplies), the CJEU set out a two-step approach to calculate the level of recovery for the branch:
    • VAT incurred on costs used exclusively to support the head office’s business
    • VAT incurred on costs which support the branch’s own business as well as that of the head office The CJEU considered that for the first type of costs, the VAT deduction right should consider:
    • The activities carried out by the head-office (“look through approach”)
    • Whether those same activities would have given a VAT deduction right in the Member State of the branch if in the VAT scope of that State
  • The CJEU ruled that, when the head office carries out both taxable and VAT exempt activities, the branch is entitled to recover VAT on its costs where they relate directly to the head office’s taxable transactions but only to the extent that those supplies would also carry a recovery right in the branch’s location.
  • For the second type of costs, those supporting the branch’s own business as well as that of the head office, a similar approach applies. In this case, the branch is entitled to recover VAT on its costs where either they relate directly to or to the extent of the taxable transactions of the branch and those of the head office (in the latter case, only to the extent that the supplies would also carry a recovery right in the branch’s location).
  • CJEU held that VAT incurred by a branch which provides support to its head office can be recovered by ‘looking through’ to the head office’s supplies. The mechanism for calculating the level of recovery is, however, not straightforward and should be analyzed on a case-by-case basis.

Implications

  • The CJEU is clear that a branch which supports its head office can recover associated VAT costs, subject to partial exemption considerations. Where those costs have a direct link to the head office’s taxable supplies a straightforward recovery right exists to the extent these supplies would be taxable if in the VAT scope of the Member State where the branch is located (even though the branch-to-head office service is a not treated as a supply).
  • For VAT on costs that cannot be allocated to a specific activity, the prorata system applies. The CJEU clarifies the approach to follow for the calculation of the prorata. In particular, the taxable transactions of the head office would give raise to a recovery right for the branch only if the transactions would also carry a recovery right in the branch’s location. For costs which support both the branch and the head office, the judgment would suggest that the head office’s entire turnover together with the one of the branch must be included in the recovery calculation. Depending on the respective turnover of the branch and the head office, this might create peculiar results.
  • Although not commented on by the CJEU, VAT deduction considerations should be similarly addressed for branch-to- branch transactions.
  • It is worth noting that the CJEU only refers to a turnover based prorata (the so called “general” prorata). The use of other allocation keys and special prorata, as is often the case in Luxembourg, should be carefully analysed and on a case by case basis.
  • Questions remain where VAT groups are created or in case of a branch with a head office outside the European Union.

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