ECJ - Morgan Stanley case – towards multiple deductible proportions for mixed branches
In its decision, the ECJ by developing an allocation-based approach, points the way towards multiple VAT recovery ratios, which will undoubtedly give rise to questions and significant difficulties for operators and tax authorities conducting audits on the VAT recovery rights of branches involving cross-border data.
The question decided by the ECJ concerns the determination of the right to deduct VAT charged on expenditure incurred by the French branch of a bank whose head office is located in the UK and having opted for VAT in the Member State (“MS”) in which it is registered (France).
1. Regarding expenditure used exclusively for the transactions of the London head office (for which it received transfers from the head office), the ECJ confirms that the VAT charged on mixed-use expenditure (relating to both taxed and VAT-exempt transactions of the head office) is deductible up to a deductible proportion that only takes into account the turnover, VAT excluded, of the transactions for which this expenditure was incurred:
- In the numerator: the turnover relating to the head office’s taxed transactions which would also be eligible for deduction if these transactions had been carried out in the MS in which the branch was registered (including transactions subject to VAT following the election of this option).
- In the denominator: the turnover relating to the head office’s taxed and VAT-exempt transactions for which the mixed-used expenditure was incurred.
Therefore, this deductible proportion will only take into account the income from the transactions carried out by the head office for which the mixed-use expenditure incurred by the branch was used.
2. Regarding general costs (expenditure used for both transactions carried out by the branch in the MS in which it is registered and transactions of its head office carried out in another MS), the deductible proportion is as follows:
- In the numerator: (i) the taxed transactions carried out by the branch in the MS in which it is registered and (ii) the taxed transactions of the head office in respect of which VAT would also be deductible if they had been carried out within the MS in which the branch was registered
- In the denominator: (i) the transactions carried out by both the branch and (ii) the head office.
Contrary to the position of the general advocate, the principle that a single system of deductible proportion should apply was rejected.
Casting a new light on its previous decision (Le Crédit Lyonnais -LCL - C-388/11), the ECJ states that it did not intend to exclude worldwide deductible proportion and in particular, that it should be possible to take into account transactions carried out by a permanent establishment of the same taxable person located in another MS having a direct and immediate link with expenditure incurred by another member state. New questions should arise on the impact of this decision on the calculation of the head office’s deductible proportion when it incurs expenditure specific to certain foreign branches.
This decision’s collateral consequences in respect of VAT are significant: adjustment of deductions, option for the application of a general lump sum VAT deductible proportion on expenditure and possible impact on payroll tax.
This decision, far from simplifying the rules for determining the branches’ right to deduct will re-open the debate on those applicable to head offices.