Branch's VAT recovery must take into account head office's activities

VAT expert Stuart Walsh at Pinsent Masons, the law firm behind Out-Law.com, said: "The decision requires affected businesses operating a branch network to undertake a series of complicated and administratively burdensome calculations in order to determine whether they are properly recovering VAT incurred on branch expenditure.  For businesses with UK branches the position is further complicated by the continuing uncertainty surrounding Brexit, which will inevitably inform HMRC's response to the decision."

The Paris branch of Morgan Stanley provided banking and financial services for French clients and also supplied support services to its UK head office. The supplies to French clients were subject to VAT as a result of an option to tax in French VAT legislation, and so Morgan Stanley sought to fully recover VAT incurred on its expenditure. The French tax authority said that the branch was not entitled to disregard the supplies to its head office in calculating the recoverable VAT, and referred the question to the Court of Justice of the European Union (CJEU).

The CJEU said that the branch's recovery of VAT on costs associated with supporting the UK head office had to take into account the head office's activity. Where the expenditure related exclusively either to support of the head office's taxable or exempt activities the VAT would, respectively, be fully recoverable (but only if there is a corresponding right to recover the VAT in the member state in which the branch is established); or fully irrecoverable.  Where the expenditure related to a mix of taxable and exempt activities, a complicated calculation is required, which takes into account the specific activities of the head office.

The court's decision appears to endorse a turnover based calculation for determining the recoverable amount of VAT where the costs incurred by the branch are used partly by the head office and partly by the branch.

Stuart Walsh added: "Turnover based calculations are not common because of the potentially distortive effect of certain high value transactions. As such, a used based method is often preferred for the purposes of calculating a fair and reasonable rate of VAT recovery. It will be interesting to see if this point is the subject of further clarification in due course."