Credit Lyonnais decision shows deficiencies in EU's VAT treatment of international branches, says expert

The Court of Justice of the European Union (CJEU) ruled that French bank Crédit Lyonnais could not take into account the turnover of its foreign branches for the purposes of calculating deductible VAT. However VAT and indirect tax expert Darren Mellor-Clark of Pinsent Masons, the law firm behind Out-Law.com, said that the ruling "appeared to chip away" at earlier court decisions in which branches within the EU were held to be part of the same 'single taxable person' for the purposes of intra-company supplies.

"Many banks and financial services businesses operate business models which place key functions in various locations, each linking to conduct business and satisfy consumer need," He said. "However, it would seem that, in this regard, the VAT system remains wedded to a 'silo-based' view of the EU with strictly defined national borders. It would appear that the concept of globalisation still remains alien to a large section of the VAT system."

"In particular, the CJEU's apparent treatment of the branches as quasi-independent businesses appears to chip away at the principles of a 'single taxable person' established in the earlier FCE Bank judgment. With the decision in the Skandia case on cross-border inter-company recharges looming, one wonders if these are ominous smoke signals of the court's thinking ahead of considering the issues of supplies between branches and head offices once again," he said.

Although headquartered in France, Crédit Lyonnais has branches in other EU member states and in non-EU countries. It had traditionally taken into account the amount of interest on loans granted to its foreign branches when it was calculating its deductible proportion of VAT. Following an audit by the French tax administration, the bank was issued with two adjustment notices and a VAT assessment of approximately €31.7 million for 1988-90. The bank paid this but then began a refund action in the French courts, claiming that its head offices and branches were all part of the same 'economic entity'.

In its judgment, made following a referral by the French courts, the CJEU found that whether a 'taxable person' was entitled to a repayment of VAT depended solely on the place where it was established. Companies with a principle establishment in one member state and a fixed establishment in another must therefore be considered as being established in that second member state for activities conducted there, and so could no longer claim a refund of VAT, it said. In addition, the turnover of branches established in 'third' countries, outside of the common EU system of VAT, could not be taken into account when determining the deductible proportion of VAT, it said.

"The deduction system is meant to relieve the trader entirely of the burden of the VAT payable or paid in the course of all his economic activities," it said in its judgment. "The common system of VAT consequently ensures complete neutrality of taxation in all economic activities, whatever their purpose or results, provided that they are themselves subject, in principle, to VAT."

"It must be held that, in so far as the calculation of the deductible proportion constitutes an element of the deduction system, the manner in which that calculation must be carried out falls, along with that deduction system, within the scope of the national VAT legislation to which an activity or transaction must be linked for tax purposes," it said.

As the setting and administration of a method for any deduction was a matter for individual member states, only those taxable persons established within that member state could be subject to that particular method, it said. If a firm had a 'fixed establishment' in another member state, that establishment would need to seek any deductions it was entitled to from the tax authorities in that member state, it said.

"Since the Court has held that the fixed establishment, within the meaning of the [VAT Directive], situated in a member state and the principal establishment situated in another member state constitute a single taxable person subject to VAT ... it follows that a taxpayer is subject, in addition to the system which applies in the state of its principle establishment, to as many national systems of deduction as there are member states in which it has fixed establishments," the CJEU said.

Allowing the bank to use the turnover of its fixed establishments in other member states for the purposes of the system of deduction in its home state could "seriously [jeopardise] ... the rational allocation of the spheres of application of national legislation in VAT matters", the CJEU said.