The European Court of Justice (“CJEU”) released its decision in the Morgan Stanley & Co International plc (“Morgan Stanley”) (C-165/17) on 24 January 2019.
The case involved the VAT recovery entitlement of a French branch which provided services to its UK head office and will be of particular interest to Financial Services companies which operate via a branch network and which suffer a VAT recovery restriction on their costs.
In summary the CJEU held that VAT incurred by a branch which provided support to its head office is entitled to recovery by ‘looking through’ to the head office’s supplies. The mechanism for calculating the level of recovery is, however, not straightforward and impacted businesses across Europe will need to understand and assess how this judgment impacts their VAT recovery position going forward.
As a reminder, from our previous alert issued last October following the Advocate General opinion, the case concerns Morgan Stanley International’s French branch which had two main activities (i) the provision of banking and financial services to local customers (which were VAT taxable as it has exercised an option to tax under local French VAT law) and (ii) the provision of services to its UK head office. The French branch recovered VAT in full on the basis that its French supplies were taxable and its branch support activities were outside the scope from a French VAT perspective.
However as the UK head office used these support services to make VAT exempt supplies in the UK, the French Tax Authorities challenged this and denied full recovery, following an audit. Referring the matter, the French Courts asked the CJEU questions around the correct recovery approach both for costs which related exclusively to Morgan Stanley Paris’s head office support as well as overhead costs covering both its activities.
The CJEU has held that a branch which incurs VAT in relation to both its own customers and support services provided to its head office may recover its VAT costs. This is subject to a complex recovery approach which reflects the fact that the business made VAT exempt supplies (which do not carry a recovery right). The CJEU set out a two-step recovery process for:
For the first pot of costs which are used exclusively to support the head office, the branch should ‘ring fence’ the relevant VAT amounts and determine VAT recovery by reference to the specific head office business area it supports. For example, if a bank’s head office had both lending and securities trading activities and the branch support relates only to the lending division, the judgment suggests that only the turnover relating to those lending supplies should be included in the VAT recovery rate calculation. Having done so, the associated VAT costs would only then be recoverable if those supplies carried a recovery right in both Member States where the head office and branch are located.
For the second pot i.e. the general overhead or ‘mixed use’ costs – the branch would, on a simple reading of the judgment, need to undertake a calculation which includes the total turnover of the branch and the head office. Again, turnover is treated as taxable in this calculation if it relates to supplies which are treated as taxable in both locations.
The judgment also looks at direct costs related exclusively to supplies the head office makes. It states that a branch is entitled to recover its costs where they relate directly to the head office’s taxable transactions (but only to the extent that those supplies would also carry a recovery right in the branch’s location).
The CJEU is clear that a branch which supports its head office (and by extension a branch which supports fellow branches) can recover associated VAT costs, subject to partial exemption considerations. Where those costs have a direct link to the head office’s taxable supplies, a straightforward recovery right exists (even though the branch-to-head office service is a not treated as a supply and is a ‘nothing’ for VAT purposes).
For head office support costs incurred in making a mix of taxable and exempt supplies, the requirement to ‘ring fence’ specific costs and to understand the relevant VAT treatment in each location may generate technical and practical complexities, particularly where a branch acts as a hub providing support to its wider network. Businesses across Europe may as a result need additional data and resources to support a recovery entitlement and will need to consider whether or not their current methodology is fit for purpose.
For mixed-use costs which support both the branch and head office supplies, on a plain reading of the judgment it would suggest that the head office’s entire turnover must be included in the recovery calculation. This outcome seems to jar with the logic elsewhere in the judgment which requires businesses to identify costs and activities to ensure the use of VAT costs is accurately tracked and reflected in recovery calculations.
The case did not deal with the situation where a branch has both exempt and taxable activities as well as providing support services to an overseas head office/branch. This is unfortunate as it is a common fact pattern. We will have to await future Court guidance on how precisely what recovery rate methodology should apply in these circumstances.
In Ireland the current standard turnover VAT recovery methodology does not require businesses to ‘look through’ to the activities of their overseas branches or head office and therefore this will be a significant change that will have to be taken into consideration going forward. Some businesses may have over-recovered VAT by only reflecting their own local (taxable) revenue and not looking through to their head office’s partial recovery rate. By contrast other businesses already apply a look though to their head office recovery rate but precisely how the ‘look through’ is applied varies from taxpayer to taxpayer.
Businesses which provide services and functions within a branch network should consider what impact the Morgan Stanley judgment may have. Many will need to change their VAT recovery methodology to bring it into line with the judgment. In practice this may be complex as it may involve having to track where VAT costs are incurred and then map those costs to taxed transactions in overseas location(s). We anticipate this will potentially be a time consuming exercise. The judgment provides opportunities for some taxpayers but it will cause others to be impacted negatively.
If you would like to discuss the impact of this judgment on your VAT recovery methodology, please contact the EY Financial Services VAT team, listed below, to discuss further.
Eamonn McCallion firstname.lastname@example.org +353 1 221 1648
Brian Keenan email@example.com +353 1 221 2487
Aideen Farrell firstname.lastname@example.org +353 1 221 1080