ECJ: Turnover head office may impact partial input VAT recovery of branch

28/01/19

On 24 January 2019 the European Court of Justice (hereafter: ECJ) ruled in the case Morgan Stanley with respect to the input VAT recovery of the French branch of Morgan Stanley, in the situation where costs incurred by the branch are (partly) used for transactions of the UK head office.

The ECJ rules that a branch should take the turnover of the head office into account for the calculation of the partial input VAT recovery (pro rata) of costs that are used cross border. The ECJ distinguishes between (i) costs that are used exclusively for transactions of the head office in the other Member State and (ii) costs that are used both for transactions carried out by the branch and for transactions of the head office in another Member State.

What does this mean for you?

The judgment is relevant for taxable persons that are established in multiple jurisdictions through branches. The ECJ opens the door to determine multiple input VAT recovery rates based on the use of costs in different branches of a legal entity. This may lead to complex and extensive calculations.

Taxable persons in the Netherlands often suffice by calculating one input VAT recovery rate (pro rata) to apply on general costs. Based on the judgment of the ECJ in the Morgan Stanley case, the calculation would have to be more precise if the costs are used for specific transactions of foreign establishments of the business.

In addition, there will be a double layer test in case of cross border use of costs. The input VAT recovery will be limited by the legislation of both the Member State in which the costs are incurred, as well as the Member State of the establishment that (also) uses the costs. Given the different input VAT recovery limitations of Member States, this may lead to complex calculations.

In practice, we would expect that costs that are exclusively used by one establishment also are incurred by that establishment. This is a result of the Implementing Regulation, that stipulates that the recipient of a supply of service should be determined on the basis of the nature and use of the services.

The ECJ does not address the possible impact of VAT grouping in the Member States involved. Based on the Skandia case, transactions between a head office and its branch (i.e. the VAT group) may not be out of scope. If interpretations of Member States differ, mismatches may occur and it could become complex to determine the correct VAT recovery.

This judgment came as a surprise and is not in line with current Dutch practice. Therefore, we recommend to assess the impact of the case on your business. This also applies for the possible impact this may have on the ‘local’ input VAT recovery, as the ECJ seems to open the door to multiple pro rata VAT recovery rates per taxable person with this case.

Background

The French branch of the British Morgan Stanley & Co International PLC, a financial institution, carried out taxable banking- and other financial transactions as well as internal transactions with the British head office. As the French branch used the (local French) right to opt for taxation in respect of its financial transactions, it has recovered the input VAT on the costs incurred in full. This also considered costs that are (also) used for the internal transactions towards the head office.

Questions raised to the ECJ

The French authorities believed that the French branch should not be able to recover input VAT in so far it considers costs that are used for the internal transactions, as these transactions are out of scope of VAT. However, by way of mitigation, it allowed recovery of a fraction of the input VAT based on the input VAT recovery of the head office.

The local French judge decides to refer questions to the ECJ. The ECJ is asked for a preliminary ruling to determine the method the French branch needs to use to calculate its input VAT recovery with respect to (i) costs that are used exclusively for transactions of the head office in the other Member State and (ii) costs that are used both for transactions carried out by the branch and for transactions of the head office in another Member State.

Judgment ECJ

The ECJ rules that the input VAT recovery of the French branch cannot be determined based on the turnover of the transactions of the branch only. The ECJ comes to this judgment as the British head office and the French branch are one taxable person for VAT purposes. As there is one taxable person, the turnover of the transactions of the head office should also be taken into account in so far the head office (also) uses the costs for these activities.

(i) Costs that are exclusively used by head office in another Member state

If costs incurred by the French branch are exclusively used for transactions of the head office in the United Kingdom, these transactions should be the basis for the branch to determine the input VAT recovery. The input VAT recovery is calculated by a fraction based on the turnover of the transactions of the British head office the costs are used for alone. In this fraction, the taxable turnover of the transactions is the numerator and the total turnover is the denominator. As only the turnover of these transactions alone should be taken into account, it can be derived there is a possibility to determine multiple input VAT recovery rates.

(ii) Costs that are used both for transactions carried out by the branch as well as the head office

If costs incurred by the French branch are used both for transactions of the branch as well as for transactions of the head office in the United Kingdom, the calculation of the input VAT recovery should be based on both the turnover of the branch as well as the turnover of the head office. It seems unclear whether all turnover of both establishments should be included or only part thereof, as it seems for the first situation (Costs that are exclusively used by head office in another Member state).

Double layer test to determine taxable turnover

For both calculations, the ECJ adds the remark that there will be a double layer test as costs will be used cross border. This means the input VAT recovery is limited by the legislation of the Member State in which the costs are incurred, as well as the legislation of the Member State of the establishment that (also) uses the costs. The limitation of input VAT recovery of both legislations is therefore applicable on a cumulative basis.

Relation to case Le Crédit Lyonnais

With its judgment the ECJ further clarifies its judgment in the Le Crédit Lyonnais case (C-388/11). In that case, the ECJ stated that a head office cannot take into account the turnover of its branches that are located in other jurisdictions. With the Morgan Stanley case it is clear that the ECJ did not intend to limit the calculation of the input VAT recovery rate geographically. The geographical limitation in such case seems to be related to the actual use of the costs incurred.

Multiple pro rata VAT recovery ratio’s

In principle it is not possible based on the Dutch VAT Act to apply multiple VAT recovery percentages, as The Netherlands did not opt for that possibility from the VAT Directive in national law. With this case it can now be questioned whether this is correct. As also in cases Member States have not implemented the multiple pro rata option in national law, it seems possible to apply different VAT recovery ratio’s depending on use of costs. We have to see how the Dutch government / tax authorities will respond.