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CJEU issues judgment on VAT recovery of global support costs

Executive summary

On 24 January 2019, the Court of Justice of the European Court (CJEU) released its judgment in the case of Morgan Stanley International (Morgan Stanley). The case considered the Value Added Tax (VAT) recovery right for a French branch which provided services to its UK head office. The case will be of particular interest to financial services groups which operate via a branch network and which experience a VAT recovery restriction on their costs.

In its judgment, the CJEU held that VAT incurred by a branch which is used to provide support to its head office is available for 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 the European Union (EU) will need to understand how this impacts their VAT recovery position.

Detailed discussion

Background

Morgan Stanley International’s French branch supplied services to local customers (which were taxable as it had ”opted to tax” its financial supplies). It also provided services to its UK head office. It recovered its VAT in full on the basis that its French supplies were taxable and its branch support activities were disregarded from a French VAT perspective.

As the UK head office used these support services to make VAT-exempt supplies in the United Kingdom (UK), the French Tax Authorities challenged this and denied full recovery. 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.

Judgment

Following the Advocate General’s opinion released in October 2018, the CJEU has held that a branch which incurs VAT in relation to both its own customers and support services 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:

  • VAT which is used exclusively to support the head office’s business
  • ”Mixed use” VAT which support the branch’s own business as well as the head office’s

For the first group of costs, 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 those lending supplies should be reflected. Having done so, the associated VAT costs would only then be recoverable if those supplies carried a recovery right in both the head office and branch locations.

For the second group – being the ”mixed use” costs – the branch would, on a simple reading of the judgment, need to undertake a single 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). This principle seems to mirror the process of ”direct attribution” under UK recovery rules.

Impact of CJEU’s judgment

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 costs which solely support the head office 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 need additional data to support a recovery entitlement.

For costs which support both the branch and the head office, a plain reading of the judgment would suggest that the head office’s entire turnover must be included in the recovery calculation. However, this could result in a peculiar result where, for example, the head office’s turnover is far greater than the branch’s. This would also not seem to align with the approach elsewhere which requires businesses to identify costs and activities to ensure that the use of VAT costs is accurately tracked and reflected in recovery calculations.

Because the case focuses on the interaction of Morgan Stanley’s UK and French operations, the CJEU did not consider how to deal with branches and head offices located outside the EU. This is a fundamental point for large Financial Services groups and something businesses and tax authorities alike will need to consider.

In the UK, the current partial exemption standard method does not allow businesses to ”look through” to the activities of their overseas branches or head office. This may be subject to change but, of course, given the UK is scheduled to leave the EU on 29 March, it is not clear how or whether any changes will be made. While the standard method does not allow businesses to recover global support costs, many businesses have agreed a partial exemption special method with HM Revenue and Customs which do. Use of a ”sectorized” special method appears to be in keeping with the CJEU’s judgment.

Implications

Any business which provides services and functions within a branch network should consider what impact the Morgan Stanley judgment may have. For multinational groups, this review should track and map the entire intercompany supply chain to determine where and how VAT costs are reflected and whether any VAT is currently ”trapped.” It is also possible that businesses will be impacted negatively. For example, businesses may have over-recovered VAT if they have not reflected branch support services and have only reflected their own (taxable) revenue.

EYG no. 000186-19Gbl

Executive summary

On 24 January 2019, the Court of Justice of the European Court (CJEU) released its judgment in the case of Morgan Stanley International (Morgan Stanley). The case considered the Value Added Tax (VAT) recovery right for a French branch which provided services to its UK head office. The case will be of particular interest to financial services groups which operate via a branch network and which experience a VAT recovery restriction on their costs.

In its judgment, the CJEU held that VAT incurred by a branch which is used to provide support to its head office is available for 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 the European Union (EU) will need to understand how this impacts their VAT recovery position.

Detailed discussion

Background

Morgan Stanley International’s French branch supplied services to local customers (which were taxable as it had ”opted to tax” its financial supplies). It also provided services to its UK head office. It recovered its VAT in full on the basis that its French supplies were taxable and its branch support activities were disregarded from a French VAT perspective.

As the UK head office used these support services to make VAT-exempt supplies in the United Kingdom (UK), the French Tax Authorities challenged this and denied full recovery. 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.

Judgment

Following the Advocate General’s opinion released in October 2018, the CJEU has held that a branch which incurs VAT in relation to both its own customers and support services 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:

  • VAT which is used exclusively to support the head office’s business
  • ”Mixed use” VAT which support the branch’s own business as well as the head office’s

For the first group of costs, 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 those lending supplies should be reflected. Having done so, the associated VAT costs would only then be recoverable if those supplies carried a recovery right in both the head office and branch locations.

For the second group – being the ”mixed use” costs – the branch would, on a simple reading of the judgment, need to undertake a single 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). This principle seems to mirror the process of ”direct attribution” under UK recovery rules.

Impact of CJEU’s judgment

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 costs which solely support the head office 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 need additional data to support a recovery entitlement.

For costs which support both the branch and the head office, a plain reading of the judgment would suggest that the head office’s entire turnover must be included in the recovery calculation. However, this could result in a peculiar result where, for example, the head office’s turnover is far greater than the branch’s. This would also not seem to align with the approach elsewhere which requires businesses to identify costs and activities to ensure that the use of VAT costs is accurately tracked and reflected in recovery calculations.

Because the case focuses on the interaction of Morgan Stanley’s UK and French operations, the CJEU did not consider how to deal with branches and head offices located outside the EU. This is a fundamental point for large Financial Services groups and something businesses and tax authorities alike will need to consider.

In the UK, the current partial exemption standard method does not allow businesses to ”look through” to the activities of their overseas branches or head office. This may be subject to change but, of course, given the UK is scheduled to leave the EU on 29 March, it is not clear how or whether any changes will be made. While the standard method does not allow businesses to recover global support costs, many businesses have agreed a partial exemption special method with HM Revenue and Customs which do. Use of a ”sectorized” special method appears to be in keeping with the CJEU’s judgment.

Implications

Any business which provides services and functions within a branch network should consider what impact the Morgan Stanley judgment may have. For multinational groups, this review should track and map the entire intercompany supply chain to determine where and how VAT costs are reflected and whether any VAT is currently ”trapped.” It is also possible that businesses will be impacted negatively. For example, businesses may have over-recovered VAT if they have not reflected branch support services and have only reflected their own (taxable) revenue.

EYG no. 000186-19Gbl

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