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Opinion: Include Foreign Head Office Turnover When Calculating Branch VAT Recovery Rate

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The eagerly awaited Advocate Generals’ Opinion in the Morgan Stanley case (C-165/17) was released on 3 October 2018.


The facts of the case were that a French branch of a UK company carried out:

  • Services for its local customers in France, which were VAT taxable; and
  • Services for the benefit of its UK head office

The French branch fully deducted the VAT it incurred on the expenses relating to both transactions above. In doing so, the branch relied upon the Credit Lyonnais principles which prohibited looking through to the supplies made by its UK head office.

The French Tax Authorities denied full input credit for VAT incurred on costs exclusively used for the benefit of the UK head office. Instead, they allowed partial VAT deduction by applying the VAT recovery ratio of the UK head office, as reduced for any items that wouldn’t give a VAT deduction if
generated in France.

The French Tax Authorities said VAT incurred on costs incurred for both French branch customers and the UK head office was only partially deductible.

On appeal, the French Court referred two questions to the European Court of Justice:

1. Should the VAT recovery ratio used for expenses exclusively used for the UK head office, be calculated using:

  • the turnover of the French branch; or
  • the turnover of the UK head office; or
  • the overall turnover of both the French branch and the UK head office

2. Should different rules apply to expenses used for both the French branch and the UK head office?

Advocate General’s Opinion

The Advocate General suggests the Court should give the same VAT recovery answer to both (i) expenses incurred exclusively for the UK head office and (ii) to mixed expenses incurred for French branch customers and UK head office.

In the Advocate General’s view, the French branch should include transactions carried out by the French branch and by the UK head office in calculating the French branch’s VAT recovery entitlements. In applying this approach, the French branch should determine whether the UK turnover gives rise to VAT deduction rights or not. The portion of UK turnover that gives deduction under UK law should be included in the numerator if it would also give deduction rights had the turnover had been generated in France (this approach echoes the stance taken in Monte dei Paschi de Sienna). The balance of UK head office turnover should then be included in the denominator. The French branch turnover would also be added into the recovery rate calculations.

This approach is not straightforward. It implies a single pot pro rata which includes the turnover of both the French branch and the UK head office rather than a ‘two pot’ method which deals with each activity/geographical region separately. This suggested approach will not be particularly easy to implement in practice.


If the Court follows the AG’s Opinion, the suggested single pot pro rata methodology will be a significant change from current practice. Partial exemption remains an area of complexity and businesses operating cross border may wish to review the implications of this Opinion on their existing partial exemption recovery method.

This case will be closely followed in the months ahead as we await the Court’s binding judgement. Given the change of approach to recovery suggested, it is very difficult to predict whether the Court will follow this Opinion.

Interestingly, the Opinion assumed Morgan Stanley UK is not in a VAT group, thereby ignoring Skandia principles which would have presumably resulted in services provided by the branch to the head office being seen as VAT taxable supplies made by separate taxable persons with full deduction available to the French branch.

How we can help

We have a global indirect tax practice which is experienced in providing VAT advice and support. If you feel this judgment could have implications for your business, and you would like to discuss the position in more detail, please do get in touch.

Eamonn McCallion

FS Partner, Tax
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