Morgan Stanley: Recovery of input tax by branches

The Advocate General (AG) has handed down his opinion in the Morgan Stanley CJEU case, which considers VAT recovery rules for costs incurred by overseas branches.

This opinion adds another dimension to Brexit planning, which can involve creating new EU businesses with multiple establishments as well as longstanding multi-establishment arrangements. Whilst the CJEU decision need not follow the opinion of the AG, in most cases it does.

If you operate using overseas branches then you should consider your VAT recovery position now. Constable VAT can help with this.

Typically, the provision of services by a branch to its head office is disregarded for the purposes of VAT. Since the transaction is between parts of the same legal entity it is not a supply. Whilst this means that output VAT need not be charged on intra-company supplies, it is necessary to establish when, and by whom, input VAT incurred by the branch to provide such a service is recoverable.

The Morgan Stanley case

Morgan Stanley has a branch in France (MSFR) and has its head office in the UK (MSUK). The French branch incurred costs for multiple reasons;

  • To provide services to MSUK,
  • To provide services to third parties and to MSUK.
  • To provide services to third parties, these services being taxable in France.

MSFR was VAT registered in France so sought to recover all the input VAT on costs incurred by its French branch on its VAT return, asserting that because services provided to MSUK are disregarded, that only supplies to third parties should be taken into account. These third party supplies were all taxable, giving rise to 100% recovery of input VAT in France.

The French tax authorities disagreed with this, claiming that input tax incurred in relation to transactions for the benefit of MSUK related to services that are outside the scope of VAT with no recovery right (an internal head office/branch transaction).

The appeal is ongoing and the French domestic courts referred two main questions to the CJEU.

Which Member State’s input tax recovery rules should apply where:

  • Expenditure is incurred exclusively for providing support to MSUK
  • Expenditure is incurred for both transactions to third parties and for MSUK?

The Advocate General (AG) divided the answer to these questions into distinct categories of transaction and suggested how VAT recovery should be dealt with in each case. The categories were expenditure:

  1. Used exclusively to support MSUK for the purposes of allowing MSUK to carry out exempt transactions.
  2. Used exclusively to support MSUK for the purposes of allowing MSUK to carry out taxable transactions.
  3. Used to support MSUK for the purposes of both MSUK’s exempt and taxable supplies.
  4. Used by both MSUK and MSFR to allow MSFR to make its own supplies and MSUK to make a combination of taxable and exempt supplies.

The AG stated that VAT incurred on expenses relating to exempt supplies made outside France is not recoverable and, moreover, should be specifically blocked even if those transactions would be taxable if taking place in France. [MSFR had elected to make its domestic supplies subject to VAT but this option did not apply to MSUK’s supplies.] It is also stated that partial exemption or pro rata methodology should be used to calculate the recoverability of input VAT incurred in relation to both exempt and taxable supplies and this method should also be used when the costs can be split between branch and head office, both making taxable and exempt supplies.

With regard to costs relating to MSUK making only taxable supplies, the input VAT should be recoverable only if the transaction would have been taxable in both member states. This is the ‘double layer’ test which arises as a result of straddling two different taxation system and answers the question of whose recovery rules should be applicable in situations akin to the main proceedings.

The AG’s opinion could be said to be contradictory to some previous CJEU decisions, for example the Credit Lyonnaise case. The AG tried hard to explain how earlier judgments could be interpreted so as to support its opinion but HMRC did not seem to see this latitude in the Credit Lyonnaise case when it changed UK law to align with the CJEU judgment!