Morgan Stanley’s case: a “corrected” VAT recovery ratio for mixed branches?

Conclusions of the Advocate General Paolo Mengozzi, Morgan Stanley & Co International plc, 3 October 2018, case 165/17.

The requests for a preliminary ruling call for detailed rules in order to determine the right to deduct VAT of a French branch of a Bank (having elected for VAT on its banking & financial activities in France, its Member State of registration) whose head office is located in London in the following situations:

1. If the expenses are exclusively used for the transactions of the London-based head office, i.e: the expenses incurred in France resulting in payments from the head office to the branch (flows treated as outside the scope of VAT);
2. If these expenses are used for the transactions of the branch in the Member State in which it is registered as well as for the transactions of its head office.

In both situations, the Advocate General proposed to determine the VAT deduction rights of the branch with respect to a combined application of both VAT deduction rules applicable in the Member State of the head office (based on the principle of allocating the expenses to the transactions carried out by the head office with third parties) and those applicable in the Member State of registration of the branch. According to this proposal:

1. Expenses exclusively used for the head office’s taxable transactions would be eligible for a full deduction provided that they give rise to a right to deduct in the Member State in which the deduction of VAT is requested (i.e. in the Member State in which the branch is registered).
2. Expenses exclusively used for the head office’s exempt transactions would not give rise to a right to deduct VAT (without considering whether these transactions would have given rise to a right to deduct in the Member State in which the refund is requested).
3. Expenses used for both taxable and exempt transactions of the head office would be eligible for deduction based on a “corrected” deductible proportion. This deductible proportion would be determined based on the rules of deduction applicable in the Member State of the head office and the proportion of the transactions in respect of which VAT is deductible will give rise to an “actual” deductibility of VAT only if it is also eligible for deduction in the Member State in which the branch is registered (the exercise of a local (French) option to have specific transactions of the branch become liable to VAT should be taken into consideration at this stage). Finally, it is suggested to aggregate to this “corrected” deductible proportion the turnover achieved by the branch with its own customers.

In practice, this proposed set of rules would oppose to the Morgan Stanley’s position consisting in a VAT recovery ratio exclusively determined on the basis of the transactions carried out by the branch with third parties. Furthermore, it would involve a certain level of complexity generating administrative burden for taxable persons and difficulties of application in specific situations (e.g. expenses incurred for a branch registered in another Member State, etc.).

At last, a significant deterioration of the deduction rights will arise each time the percentage of the branch’s transactions in respect of which VAT is deductible will be lower than the percentage of the branch’s local transactions.

The Court’s decision is particularly expected as these conclusions are definitively not in favour of an easier management of the relations between head office and branches.