Deduction of input tax in a head office/branch relationship
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The Court of Justice of the European Union delivered its judgment in the Morgan Stanley case on 24 January 2019, as explained below.
The Court of Justice of the European Union (CJEU) was questioned about the rules for determining the right of deduction of the tax charged on expenditure borne, in France, by the branch of a bank whose head office is established in the United Kingdom. The expenses in question are wholly or partially used for financial transactions carried out from the UK and are not all eligible for the deduction of tax.
As permitted by French regulations, the bank opted for the taxation of its transactions. Any transactions carried out on behalf of third parties from the French branch are therefore eligible for the tax deduction, while only a very small fraction of the transactions carried out from the UK principal establishment are eligible for tax deduction of due to the exemption applicable to all financial transactions.
The CJEU's decision
In its judgment delivered on 24 January 2019, the CJEU first reminded that the head office and its branch theoretically constitute one and the same taxable person, and the transactions carried out between them are non-taxable internal flows that cannot be taken into account when determining rights of deduction, and especially when calculating the prorata, which only includes transactions carried out with third parties.
The CJEU also reminded that the prorata rule only relates to mixed-use expenditure that is used both for taxed transactions and exempt transactions that are not eligible for tax deduction.
In the Morgan Stanley case, the CJEU identifies two categories of mixed-use expenditure borne by the French branch.
The first category of expenditure covers expenses borne in France but that are only used for taxed transactions and exempt transactions carried out from the British head office.
For this expenditure, the right of deduction must be determined according to a prorata whose numerator is the taxed transactions carried out by the principal establishment, providing that they would also be eligible for the tax deduction if they had been carried out in the member state where the branch is registered, and whose denominator is all of the transactions to which the said expenditure is allocated.
The CJEU states that this prorata is not necessarily the head office’s prorata as it is only composed of the transactions for which the expenditure was used. It justifies this position by explaining that the expression "for all the transactions carried out by the taxable person" in article 173 paragraph 1 first subparagraph should be understood to refer solely to the transactions to which the mixed-used expenditure in question is allocated, and none of the other economic transactions carried out by the taxable person.
The second category of expenditure covers expenses used for all economic transactions carried out by the taxable person, in other words those carried out from the head office and the branch established in another member state.
For this mixed-use expenditure (classed as "general costs"), the deductible prorata includes all turnover generated by the taxable person. However, taxed transactions carried out from the head office can only be included in this global prorata's numerator if they would also have been eligible for the tax deduction in the state where the branch is located if they had been carried out there.
The CJEU in this way refers to one of its previous judgments (Case C-388/13, judgment of 12 September 2013) in which it ruled that:
- Firstly, a single deductible prorata based on the provisions of article 173 paragraph 1 could be applied to mixed-use expenditure borne by a taxable person in a member state of the European Union (EU); and
- Secondly, this prorata could not include the turnover generated by branches established in other member states of the EU or outside the EU.
It also seems to us that the method recommended by the CJEU for determining the right of deduction of mixed-use expenditure solely borne for transactions carried out abroad, based on the inclusion of the transactions for which each expense is actually used, is less in keeping with the deductible prorata rule provided for in article 173 paragraph 1 of the VAT Directive than with one of the derogating methods that member states are permitted to use in accordance with paragraph 2 of this article.
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