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Luxembourg Tax Alert 2018-19

Luxembourg Tax Alert 2018-19



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New approach suggested for input VAT recovery of branches: AG’s opinion on Morgan Stanley

On 3 October 2018, Advocate General (hereafter AG) Mengozzi released his opinion on the Morgan Stanley case (C-165/17).

1. Summary of facts:

Morgan Stanley & Co International Plc. (hereafter Morgan Stanley) is a head-office established in the UK and disposes of a branch, which is VAT registered in France.

The French branch provides:

  • Banking and financial services to local clients for which it has opted for taxation1;
  • Supplies to the UK head-office in exchange for cash transfers, including the allocation of costs incurred by the branch for the purposes of the activities of the head-office.

In this respect, the French branch has asked for an input VAT recovery on the costs it incurred in relation to both categories of supplies provided to third parties and its head-office.

However, the French VAT authorities have challenged the method used by Morgan Stanley for the calculation of the input VAT recovery of its French branch.

The case was taken to the French State Council, which asked the Court of Justice of the European Union (hereafter CJEU) for a preliminary ruling on the following questions:

  1. Which prorata basis of deduction should be used for the costs incurred by the French branch for the exclusive benefit of the UK head-office?
  2. How should the input VAT recovery be calculated on the costs incurred by the French branch for the purpose of supplies made to both the UK head-office and its French clients ? 

It is worth noting here that these questions relate to two former cases where the CJEU had to deal with similar questions: the LCL2 affair and the order ESET3 .

On LCL, the CJEU ruled that the turnover realized by foreign branches should be excluded from the prorata rate applied to the general costs incurred by a head-office.

On ESET, it decided to issue an order4  to answer the question of whether a branch (registered in a Member State for the payment of VAT) of a company established in another Member State could recover input VAT on the costs attributable to internal supplies made to its head-office. The CJEU stated that the branch could recover input VAT incurred in the Member State of registration in cases where the branch was mainly carrying out internal operations not subject to VAT, provided that the head-office in question is granted the right to recover its input VAT and the costs incurred by the branch are linked with the taxable activity of the head-office.


2. Approach taken by AG Mengozzi:

2.1. The approach for the calculation of a pro rata deduction with regards to the costs incurred by the French branch for the exclusive benefit of the UK head-office

To determine the answer to this question, the AG’s approach is to identify two steps in the analysis.

  • The first step consists of identifying the category of transactions (opening a right to deduction or not) realized in the Member State where the head-office is located. Only if such transactions open a right of recovery, a second step should be undertaken.
  • The second step relates to the question of determining if such operations would also open an input VAT recovery right in the Member State where the branch is located. 

If the costs incurred by the branch are exclusively for the benefit of the head-office-exempt transactions, then the input VAT deduction can be refused without necessitating to check this right in the Member State where the branch is located.

The AG underlines that this approach is coherent with the principle that input VAT recovery right should be demonstrated by a direct and immediate link with the goods and/or services acquired for the purposes of the economic activity of the taxable person.

Further, the AG’s view is that the “taxable person,” Morgan Stanley, is constituted by both the branch in France and its head-office in the UK. Therefore, one should not consider only the transactions performed by the branch with its local clients to determine the input VAT deduction right of Morgan Stanley.

The second point of the analysis relates to the determining of the prorata rate applicable.

For the AG, only a combined application of the VAT rules existing in France and the UK, for the determination of the pro rata, should be acceptable. Further, this should allow the maintenance of the neutrality and territorial principles.

The AG also underlines the fact that the input VAT deduction right should be granted only in case a transaction realized in the UK has opened a right to deduction when performed in France.

This method seems neither to be the easiest nor the most advantageous for the taxable person, who would always face a restrictive combined approach, depending on the Member States’ (sometimes divergent) interpretation of the input VAT recovery right calculation and scope of VAT exemptions. However, in Morgan Stanley’s case, such calculation appears to be the only possibility, considering the option to tax financial services in the French tax law.

The following example illustrates this limitation:

Turnover by type of services provided Input
VAT recovery right (in the head-office country) 40/100
Input VAT recovery right (in the
branch country)
Conclusion: recovery right applicable for expenses incurred in the branch
country in connection with the head-office activity
100        A





2.2. The rules applicable for the calculation of the input VAT recovery on the costs incurred by the French branch for supplies made for the benefit of both the UK head-office and its French clients

In analyzing this question, AG Mengozzi explains the rules that should apply to the mixed expenses incurred by the French branch.

As far as possible, the expenses incurred by the French branch should correspond with the general expenses of the taxable person considered in its globality. These should open the right to an input VAT recovery in France via the calculation of a single pro rata for all the expenses. This pro rata should take into consideration the totality of the turnover generated by the branch and head-office.

2.3. Determination of the input VAT recovery: summary

Based on the above and depending on the type of expenses incurred by the French branch, it is possible to summarize the rules for the determination of the input VAT recoverable of the latter as follows:

tax alert 2018-19

This last prorata calculation method does not appear to be in line with the neutrality principle and the effective allocation of the costs to the corresponding turnover. Further, it might create distortions in case the proportion of the costs incurred in one Member State is not allocated correspondingly to the turnover generated by the branch and the head-office:

Expenses Allocation of the costs Turnover realized
100 10% to the branch
90% to the head-office
Branch = 100,000
Head-office = 1,000

In this scenario, based on AG Mengozzi’s approach, the prorata should be calculated taking into consideration the transactions performed by the branch, while the majority of the costs incurred are for the head-office.

3. Interrogations arising from the AG’s analysis

In addition to the above issues, the analysis made by AG Mengozzi does not take into account several situations, in particular:

  • The case where the head-office would be located outside the European Union (and therefore how in this case would the input VAT recovery right of the branch be calculated);
  • The case where the head-office and/or the branch would be members of a VAT group and how Skandia5 /FCE Bank plc6 would then be applied7. This could lead to difficulties with regards to the calculation of the input VAT recovery right in similar cases;
  • The case where the prorata is determined by an allocation key different from the one based on the turnover generated. This is a situation often encountered in Luxembourg following the application of the principles included in Circular 765.

Besides, in cases where the head-office realizes a high taxable turnover, this could also lead to practical problems —companies might be encouraged to create a channeling toward the establishment generating the highest taxable turnover in order to increase their input VAT recovery right.

Finally, the question of whether AG Mengozzi’s approach will be followed by the CJEU should have significant implications in the context of the coming Brexit. However, structures tend to be more organized when following a model similar to the one used by Morgan Stanley. The outcome in this case and final decision of the CJEU should therefore be closely monitored.


further to the article 137 paragraph 1 under a) of the 2006/112/EC Directive (hereafter VAT Directive) and article 260 CGI

C-388/11, Le Crédit Lyonnais

C-393/15, ESET

Instead of a judgement, this category of decision is allowed by the Rules of Procedure of the CJEU, when the answer to a question does not raise specific doubts and can be clearly inferred from the case-law of the CJEU


C-210/04, as a reminder, the CJEU stated that the transactions between a head-office and its branches should be considered as “internal”, i.e. falling outside the scope of VAT

let’s however remind that in France, article 11 of Directive 2006/112/CE (VAT Directive) on the VAT group regime is not implemented, while it is the case in several other Member States)


Any tax advice in this communication is not intended or written by KPMG to be used, and cannot be used, by a client or any other person or entity for the purpose of (i) avoiding penalties that may be imposed on any taxpayer or (ii) promoting, marketing, or recommending to another party any matters addressed herein.The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity.

Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

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