No turnover of foreign branch in local VAT pro rata deduction! Outcome of Crédit Lyonnais case
12 September 2013
The Court of Justice of the European Union (CJEU) released its judgment today in the Crédit Lyonnais case (C-388/11), finding that in determining the deductible proportion of VAT applicable, a company, the principal establishment of which is situated in a Member State, may not take into account the turnover of its branches established abroad.
Facts of the case and questions referred
The main issue in the Crédit Lyonnais case is whether a company with branches outside the Member State of its headquarters performing both activities that give rise to a VAT deduction right and activities that do not, can take into account the turnover of its foreign branches for the calculation of its input VAT-deduction right.
Crédit Lyonnais is a credit institution whose head office is located in France and which has branches within and outside the European Union. To calculate its deductible proportion of VAT for the period from 1 January 1988 to 31 December 1989, the head office of Crédit Lyonnais took into account interest arising under loans granted by it to its foreign branches. The French tax authorities challenged the calculation made by the headquarters of the bank Crédit Lyonnais of its deductible proportion of VAT, on the basis that transactions entered into between a head office and its foreign branches are disregarded for VAT purposes (the interest received has therefore been improperly taken into account). The bank filed administrative appeals but these were rejected by the French tax authorities. In response, the bank changed its argument and filed new administrative appeals arguing that it was entitled to take into account interest paid to its foreign branches by their customers for the calculation of its deductible proportion of VAT, again to no avail. Having taken the case to court, the bank appealed all the way to the French Council of State, which on 11 July 2011 requested a preliminary ruling from the CJEU.
The questions referred to the CJEU were in substance the following:
1.To calculate the deductible proportion of VAT, must the principal establishment of a company established in a Member State take into account the income generated by each of its branches established in another Member State and, in turn, must those branches take into account the total amount of income falling within the scope of VAT achieved by the company?
2.Must the same approach be adopted for branches established outside the European Union, particularly in light of the right to deduct that exists in relation to certain banking and financial operations carried out for the benefit of customers established outside the Community?
3.Might the answer to the first two questions vary from one Member State to another, depending on the options made available by the VAT Directive?
4.If the answer to either of the first questions is yes, (i) is it appropriate to limit the application of such deductible proportion to calculation of rights to deduct VAT that has been charged on expenses incurred by the principal establishment for the benefit of foreign branches, and (ii) must income achieved abroad be taken into account in accordance with the rules applicable in the State of the branch or in the State of the principal establishment?
Relevant VAT framework
The European common system of VAT is based on the principle that a taxable person should not bear any input VAT burden in relation to its taxable outputs. Accordingly, the VAT system provides for the deduction/refund of input VAT.
A taxable person which is a credit institution will generally have activities comprising both outputs that give rise to a right of deduction and outputs that do not give rise to a right of deduction. The input VAT that such a taxpayer incurs for the realisation of both types of outputs will only be deductible to the extent it relates to those outputs that give rise to a right of deduction. Except where a direct and immediate link can be established between the costs (and thus the input VAT) and one or the other category of outputs, the VAT Directive provides for a pro rata rule to determine the deductible VAT. The applicable pro rata is determined using a fraction where the numerator is the turnover resulting from the outputs that give rise to a right of deduction/refund, and the denominator is equal to the numerator increased by the total turnover of all the other outputs that fall within the scope of VAT.
Comments and Conclusion
This case is of utmost interest as, to date, there is no ‘harmonised’ practice in the EU with respect to the inclusion of branches’ turnover for the calculation of the head office’s deductible proportion.
Under Belgian VAT rules, supplies between the various establishments of a single taxable person are disregarded. Further, for the computation of the general deduction ratio applicable to a taxable person’s Belgian establishment, no account is taken of transactions executed in other countries when they are performed by separate establishments of the taxable person and the related expenses are not borne directly by the taxable person’s Belgian establishment.
The Czech tax authorities follow the principles established in the FCE Bank case and disregard inter-branch transactions. To a certain extent, this applies even within the context of VAT groups. Nevertheless, in certain specific areas, the view taken by the tax authorities is that the territorial principles should prevail. While no official guidance has ever been issued, indications exist that the authorities tend towards the view that, in the absence of any clear legal framework, the territorial approach should also apply with respect to calculation of pro rata in cross-border situations. However, this approach has not always been followed in practice and there have been cases where foreign branches’ turnover has been included for the purposes of calculating the Czech head office’s deductible proportion.
In Germany, based on the principles of the unity of a business (Einheitlichkeit des Unternehmens), non-German branches of a German taxable person are, in general, considered part of the business of the respective German taxable person for VAT purposes. However, for the purposes of the input-VAT deduction, the non-German branches are treated as independent organisational units, ie the turnover of the branches must not be considered for the computation of the general deduction ratio applicable at the level of the German taxable person.
In Italy, supplies between the Italian head office and its foreign branches are disregarded for VAT purposes. In the absence of specific guidelines, the deduction proportion is generally calculated solely on the basis of the turnover within the meaning of Italian VAT law. This view seems to be supported by arguments based on judgements of the Italian Supreme Court that implicitly distinguished between an establishment in Italy and its foreign head office. Any turnover obtained by other establishment of a single taxable person or its head office in a European country other than Italy is generally disregarded when calculating the deductibility ratio.
In Luxembourg, services exchanged between a head office and its foreign branches have, up until now, been disregarded for VAT purposes but the aggregation of the turnover realised by the branches has been authorised in some cases for the calculation of the deduction right of the head office, whether or not advantageous for the VAT taxpayer.
In the Netherlands, services between a head office and its branches are disregarded for VAT purposes. However, it is not clear whether services between the head office and its branches or the transactions executed by the branches should be taken into account when calculating the deduction ratio applicable to the Dutch head office. There is no Dutch legislation or policy in this respect.
Under Polish law, supplies between the establishments of a single taxable person are not considered VAT-able supplies. However, there are some controversy as to whether, for the purpose of calculating the deduction proportion, it is necessary to take into account not only Polish VAT but also turnover from transactions subject to VAT in other countries where the taxable person has establishments. Polish tax authorities currently take a territorial approach, and conclude that the deduction proportion is calculated solely based on the turnover within the meaning of Polish VAT law obtained directly by the Polish establishment of a single taxable person. Any turnover obtained by another establishment of a single taxable person or its head office in a country other than Poland, should be disregarded when calculating the deductible proportion.
Under Spanish tax law, a company with branches located outside Spain must, when calculating its input VAT-deduction right (ie the pro rata), aggregate the turnover realised in the activities performed vis-à-vis those branches, but specifically exclude the turnover allocated to the activities carried out from such foreign branches, unless the costs associated with those activities are borne by branches located within Spanish territory.
In the United Kingdom, transactions between establishments of a single legal entity are generally disregarded for VAT purposes. Whilst United Kingdom legislation does not specify expressly whether supplies made by a foreign branch of an entity established in the United Kingdom are to be taken into account in determining that entity’s input tax recovery, in practice a territorial approach is taken which takes into account only the activity of the United Kingdom establishment.
The FCE case (C-210/04) stated that a branch and its head office, in their reciprocal relationship, were deemed to form a single VAT taxpayer and that no services exchanged between them could fall within the scope of VAT or create a VAT deduction right. Further to the FCE case and by stating that the turnover of foreign branches may not be taken into account by a head office, the Crédit Lyonnais case will help harmonise the European practice but also have the consequence that a non-neutral loss of VAT deduction rights will potentially be created (or officialised) at the level of head offices incurring costs for the benefit of their foreign branches.