On January 24th 2019, the Court of Justice of the European Union (the “ECJ”) published its judgment in the Morgan Stanley case (C-165/17), clarifying the rules governing the right to deduct input VAT incurred by a branch in connection with goods and services used for the purpose of transactions carried out by its head office.
Morgan Stanley’s French permanent establishment provided banking and financial services to its local customers. These services were subject to VAT, as the branch had opted to be taxed thereon in accordance with the rules applicable in France. It also supplied services to its head office in the UK. The French tax authorities, to a large extent, disallowed the deduction of input VAT relating to the expenses used solely for internal transactions between the French branch and the UK head office.
In the appeal proceedings against the additional assessments issued by the French tax authorities, the Council of State (Conseil d’Etat) referred two questions for preliminary ruling to the ECJ, regarding the rules governing the determination of the deductible portion of input VAT, incurred by a branch, on (a) expenditures used exclusively for transactions carried out by the branch’s head office established in another Member State and (b) general costs used for both transactions of the branch and transactions of its head office.
The ECJ decided, with regard to the first question, that a branch registered in a Member State should be entitled to deduct, in that Member State, all input VAT incurred on goods and services which have a direct and immediate link with taxed output transactions of its head office established in another Member State (with which that branch forms a single taxable person), subject to the condition that these output transactions would also give rise to deduction entitlement if they had been carried out in the branch’s Member State. The latter condition may notably be fulfilled in case the transactions taxed in the Member State of the head office would also be taxed in the Member State of the branch as a result of the exercise of an option by the branch in accordance with domestic legislation.
The ECJ further considered the situation where the transactions carried out by the head office are partially taxed and partially VAT-exempt and concluded that the deductible portion shall correspond to a fraction, whose (a) denominator is formed by the turnover, exclusive of VAT, made up only of the transactions for which the expenditure had been incurred (to the exclusion of the other economic transactions of the taxpayer), and whose (b) numerator is formed by the taxed transactions in respect of which VAT would also be deductible, if they had been carried out in the Member State of the branch.
On the second question, regarding the general costs relating to both, transactions to local customers as well as to services provided to the head office, the ECJ held that the prorata to be applied shall correspond to a fraction made up by (a) a denominator composed of all the transactions carried out both by the branch and the head office and (b) a numerator composed, besides the taxed transactions carried out by the branch, solely of the taxed transactions carried out by the head office, in respect of which VAT would also be deductible if they had been carried out in the State in which the branch concerned is registered.