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France: VAT cross-border pro rata, costs incurred by fixed establishment

France: VAT cross-border pro rata, fixed establishment

The Advocate General to the Court of Justice of the European Union (CJEU) issued an opinion concerning recovery of value added tax (VAT) on costs incurred by a fixed establishment that are also used for the activities of a foreign head office.


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The Advocate General concluded that such costs must be subject to a pro rata recovery that is to be calculated based on both the activities of the fixed establishment and the activities of the head office. Thus, the Advocate General found that VAT can only be recovered if turnover for which there is a VAT recovery right is generated according to the standards of the fixed establishment’s country of residence and according to the standards of the head office’s country of residence. 

The case is: Morgan Stanley, case no. C-165/17 (Advocate General’s opinion issued 3 October 2018)


The taxpayer has its head office in the United Kingdom and a branch in France. The French fixed establishment performed VAT-able banking and financial services for its French clients. It was possible to charge VAT on these services due to an option-to-tax rule under French VAT law. The French fixed establishment also performs activities for the UK head office that were not subject to VAT because these activities took place within the same legal entity. 

The French fixed establishment fully recovered the VAT on the costs it incurred for activities related to the head office. The taxpayer took the position that the activities for the UK head office were to be ignored, which meant that for the purposes of calculating the right to recovery, only the French-sourced turnover remained and this allowed VAT recovery. 

Following a tax audit, the French tax authorities determined that the French fixed establishment’s VAT recovery on costs must be corrected insofar as these costs were also used for activities performed by the UK head office. The UK head office did not have full VAT recovery entitlement, but only a pro rata recovery. 

A French court filed a request with the CJEU for a preliminary ruling on the following issues:

  • Cost category 1 (costs used by the head office)
  • Cost category 2 (costs used by the head office and the fixed establishment)

Advocate General’s opinion

The Advocate General made the following determinations:

  • The UK head office and the French fixed establishment were a single taxpayer for VAT purposes. 
  • The activities (cost recharges) by the French fixed establishment to the head office were not relevant for VAT purposes. 
  • The VAT recovery right for such irrelevant activities cannot automatically be refused (cost category 1). 
  • It was inappropriate to determine the recovery right for cost category 1 and 2 solely on the basis of the activities of the French fixed establishment.
  • A pro rata recovery rate must be determined that takes account of both the activities of the UK head office and the French fixed establishment. This pro rata recovery rate would apply to both cost category 1 and 2. 

KPMG observation

What is the effect of such a “double test” in cross border situations? It appears from the opinion of the Advocate General that for purposes of VAT recovery entitlement, it makes a difference in which EU Member State the costs arise. In this respect, a proportion of a potential VAT recovery limitation can probably be avoided by directly incurring the costs in the country where the establishment is located, which undertakes the activities to which the costs relate. After all, if in the pending case, the costs had arisen directly in the United Kingdom, the VAT recovery entitlement would only have to be assessed on the basis of UK standards. Taxpayers are not always free to choose the location where costs are reported for VAT purposes, but this can to some extent be managed.

The case covers the years 2002-2009. The question is whether the double test is still entirely appropriate in light of the place-of-supply rules in business-to-business (B2B) situations (as effective since 2010), and the trend towards taxation of services in the country where they are used. The EU VAT Implementing Regulation (July 2011) dictates that as a starting point, the nature of services and their use must be the basis for determining the establishment that is to be regarded as the customer. This means that the standard B2B services could possibly fall outside cost category 1, because these may be regarded as having been purchased by the UK head office. 

Furthermore, including the turnover of the UK head office in the pro rata recovery calculation of the French fixed establishment could have a disruptive effect. If the turnover of the UK head office is a multitude of the turnover of the French fixed establishment, then the UK head office could have a disproportionately large influence on the outcome of the pro rata recovery calculation. This is especially true if the general costs incurred are in fact mostly related to activities of the French fixed establishment itself. 

The potential recovery limitation caused by applying a pro rata standard at the entity level can probably be avoided by allocating expenditure as much as possible directly to turnover with a right to recover input VAT. The Advocate General’s opinion is seen as leaving room for such a conclusion. Note that the opinion does not address the principle of actual use by, for example, the head office (or a business unit) if no direct attribution takes place. Within the Dutch (and broader European) context, the principle of actual use could offer an alternative to a pro rata recovery calculation. 


Read an October 2018 report prepared by the KPMG member firm in the Netherlands

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