Two-step analysis required for VAT deduction in cross-border situations


The Court of Justice of the European Union (hereafter CJEU) released an important decision regarding the input VAT recovery methodologies to be used by taxable persons having a head-office and a branch located in 2 different Member States.

In the case at hand, Morgan Stanley & Co International Plc was a head-office located in the United Kingdom and having a branch in France. On the one hand, the branch provided banking and financial services to its usual clients established in France; for these services the branch had opted to taxation. On the other hand, the branch provided supplies to its head-office against which it received cash transfers.

The French State Council made a preliminary reference to the CJEU asking 2 questions of interpretation relating to the input VAT which could be recovered at the level of the French branch.

It is here to be reminded that Morgan Stanley had deducted its input VAT in full based on the input VAT recovery rate of the French branch, which the tax authorities challenged.




The decision of the CJEU was divided into 2 parts depending on the type of expenses incurred by the French branch:

  • The first part concerned the input VAT recovery of the branch on the costs incurred by the latter and exclusively used for the economic activity of the head-office ;
  • The second part related to the input VAT recovery of the branch on the general costs incurred and used by both the branch and its head-office.

Answer of the CJEU

Type of expense: Expenses used for the UK head-office exclusively

The CJEU decided in this respect that:

  • The VAT incurred by the branch for the taxed transactions of the UK head-office should be deductible on the condition that these transactions would be considered as taxable and open a right to recover input VAT in France (confirming its previous decision in C-136/99 Monte Dei Paschi Di Siena).
  • The VAT incurred by the branch for the exempt transactions of the UK head-office should not be considered as opening a right to recover input VAT.
  • The VAT incurred by the branch for mixed-use expenses (exempt and taxed) which are exclusively used for the UK head-office activity should lead to the calculation of a specific prorata as follows:


This calculation corresponds to a specific prorata computed only on the UK head-office turnover related to the expenses incurred by the branch.

Type of expense: Expenses used by both the UK head-office and the French branch (general costs)

As regards this category of expenses, the CJEU stated that the input VAT recovery of the French branch should be determined as follows:

This calculation corresponds to a general prorata in relation with both the activities of the branch and the head-office. It is based on the total turnover of both establishments.

This case-law should be carefully taken into consideration by banks having a structure comparable to the one of Morgan Stanley (head-office / branch located in 2 different EU Member States) when establishments incur expenses in connection either with the other establishment or with both of them. Indeed, it is now required from these taxable persons to systematically establish to which category of expense each cost incurred by one of them should be allocated. Taking into account the above explained rules, such allocation should allow to ascertain their input VAT recovery and calculate the correct prorata.

The application of this case will however make the rules for input VAT recovery determination more complex in head-office/branch structures. Besides, some situations remain uncertain (e.g. one of the establishment is located outside the EU, or is a member of a VAT group).




By Laurence Lhote, Head of VAT, Indirect Tax Partner, KPMG Luxembourg


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