In a judgment handed down on 12 September 2013 (case C-388/11, Le Crédit Lyonnais), the Court of Justice has clarified the operation of the right to deduct in relation to companies which have foreign branches.
The Court held that a company is not entitled to use the turnover of its foreign branches (whether they are located in a member state of the European Union or in a third state) in calculating the deductible proportion of the principal establishment's expenditure.
Equally, Member States may not authorise companies to use such a "worldwide" prorata in relation to a particular sector of their business (in the present case, the services provided by the bank through its foreign branches might have been thought to constitute a sector of business).
The principle adopted by the Court is that the turnover of its foreign branches should not have any impact on the right of deduction available to the French principal establishment in respect of expenses which have no connection with the activities carried out by the branches (paragraph 38 of the judgment). On the other hand, where the expenses incurred in France do have a connection with the activities of the branches – as was the case in relation to the costs of Crédit Lyonnais' principal establishment – the Court has not expressly affirmed that the deductible proportion should be calculated solely on the basis of the French turnover of the principal establishment.
Such an approach would sacrifice the principle of neutrality. It is difficult to conceive how an expense which is at least partly referable to an operation carried out through the branch can be subject to a deductible proportion calculated on the basis of a turnover figure which does not include the whole of the turnover to which the expense relates. Even on the widest interpretation the proportion can only apply to expenses which are referable to the turnover used in its calculation, whether this is taxable and/or exempt.
Equally, the Court has not stated the position as to expenses incurred by the principal establishment exclusively for the purposes of operations carried out through branches. Must the deductible amount be calculated on the basis of the principal establishment's proportion. In such a case, even though the expenses have no link with the French turnover used in the calculation of that proportion? Should an alternative method of calculation be used so as to take account of the position of the foreign branch in terms of the right to deduct? If so, how would this operate where the branch is outside the European Union?
It is now for the Conseil d'Etat, in light of the partial answers it has received from the CJEU, to resolve the proceedings between Crédit Lyonnais and the French tax authority.