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France: VAT recovery on basis of cross-border use costs

France: VAT recovery on basis of cross-border use costs

The Court of Justice of the European Union (CJEU) issued a judgment in a case concerning the value added tax (VAT) recovery of costs incurred by a fixed establishment that are also applied with respect to the turnover of a foreign head office.


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The CJEU addressed the issue how the VAT recovery on such costs is to be calculated, and found that the turnover of the foreign head office is to be taken into account given that:

  • Depending on the use made of the costs, the recovery right would be calculated on the basis of the turnover of the fixed establishment and/or the turnover of the head office. 
  • VAT can only be recovered if turnover is generated, for which there is a VAT recovery right, according to both the VAT rules of the head office’s country of residence and the VAT rules of the fixed establishment’s country of residence. 

The case identifying information is: Case no. C-165/17 (24 January 2019)


The taxpayer had 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 is possible to charge VAT on these services because of an option-to-tax under French VAT law. 
  • The French fixed establishment also performed (internal) activities for the UK head office—services that were not subject to VAT because these take place within the same legal entity. 
  • The French fixed establishment fully recovered the VAT on the costs it incurred and for all or part of these costs that were used by the head office—both turnover that gives a right to recover as well as turnover for which there is no recovery right (mixed use). 
  • The taxpayer took the position that the activities for the UK head office were to be “ignored” so that for the purposes of calculating the recovery right, only the French-sourced turnover would remain, on the basis of which there would be a (full) VAT recovery right.

The French tax authorities conducted a tax audit, and determined that the French fixed establishment’s VAT recovery on costs must be corrected insofar as these costs were also used for turnover realized by the UK head office. The head office did not have a full VAT recovery right, but applied a pro rata recovery right. A French court requested a judgment from the CJEU concerning the right to recover VAT on costs incurred by the French fixed establishment. At issue was the right to recover VAT regarding the following:

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

CJEU judgment

The CJEU assumed that the UK head office and the French fixed establishment were a single taxpayer for VAT purposes. The internal activities (cost recharges) of the French fixed establishment to the UK head office, therefore, were not relevant for VAT purposes. The CJEU explained that when determining the VAT recovery right on costs incurred by the French fixed establishment, account must be taken of the taxpayer’s external turnover, including the turnover of the foreign head office. The CJEU therefore found that it is wrong to determine the recovery right for cost category 1 and 2 solely on the basis of the external activities of the French fixed establishment—this would not correspond to the ultimate use of the costs because category 1 costs involved mixed use by the UK head office, and the ultimate use of the category 2 costs was with both the UK head office and the French fixed establishment. 

The EU VAT Directive provides that the recovery on mixed-use costs is determined on the basis of the total turnover generated by the taxpayer. 

  • For cost category 1, however, the CJEU only examined a part of the UK head office’s turnover concerning the part of the (taxed and exempt) turnover of the UK head office, for which the costs of the French branch were used. Turnover generated by the UK head office on activities not related to the costs of the French fixed establishment, thus, were not to be included in the recovery calculation. Effectively this resulted in a partial pro rata determination.
  • For cost category 2, the CJEU found the pro rata recovery rate must be determined on the basis of the turnover of both the French fixed establishment and the UK head office. On the basis of the CJEU’s judgment, it is not clear whether the total French and UK turnover would be included in the pro rata calculation or only that part of the turnover for which the French branch incurred the costs. 

The CJEU applied a double test when qualifying the turnover of the UK head office. The UK head office turnover is in the first instance only regarded as turnover with a right to recover input VAT if this turnover would give a right to recover VAT under the UK VAT rules. Moreover, the UK turnover would also give rise to a right to recover VAT under the French VAT rules, taking the option-to-tax into account. This double test applied to both cost category 1 and 2. 

In this case, the CJEU qualified the impact of a prior judgment (case no. C-388/12) in which it held that a French head office was not allowed to include turnover originating from foreign fixed establishments in the pro rata recovery calculation. The CJEU concluded that the earlier judgment did not rule out the turnover of foreign branches being taken into account when determining the recovery right. The CJEU found that an important difference between the instant case and the prior case was that in the earlier case, the relationship between the costs of the head office and the turnover of a fixed establishment was not certain, whereas in the present case, this was known. 

Read a January 2019 report prepared by the KPMG member firm in the Netherlands 

Read a February 2019 report prepared by the KPMG member firm in Luxembourg

Implications for Dutch treatment of VAT recovery

The CJEU judgment differs from the Dutch practice on a number of points. In order to determine the VAT recovery of costs of a taxpayer with establishments in more than one country, the CJEU aimed to reconcile the cross-border use of those costs. From the perspective that this leads to a recovery that is more in line with the use of the costs, this can be viewed as a positive finding, but it also makes the recovery calculation more complex. The standard practice in the Netherlands is that a local pro rata recovery right is determined, which is applied to all local mixed-use costs. On the basis of Dutch policy, the turnover of a taxpayer’s foreign establishments is (also) of importance when determining the recovery right if the local costs are (also) used for the foreign establishments’ turnover. Previously, a cross-border pro rata at the entity level was often rejected, but now the CJEU now expressly kept this possibility open.

If costs are only mixed used for part of the turnover, the CJEU appears to be of the opinion that a partial pro rata must be determined in accordance with this mixed use. In this respect, (part of) the foreign turnover may be a contributory factor. What is new is that the CJEU based this on the VAT Directive’s general provisions concerning the recovery of VAT on mixed-use costs, which prescribe that a total turnover must be calculated on a pro rata basis—and not on the special recovery rules concerning actual use and sector pro rata, which can optionally be implemented by the EU Member States. The CJEU’s description is so broad that it may be necessary to extend this line to other situations. The position of the Dutch tax authorities not to allow any partial pro rata may need to be put into perspective. 

Another important point of attention is the use of a double test. This could seriously limit the recovery of VAT in cross-border situations. This double test is not currently used in Dutch practice or in many other countries, because it does not follow literally from the text of the VAT Directive. For purposes of the recovery right, it will then not only be relevant in which EU Member State the costs are incurred, but also where the turnover is generated. It is unclear what the effect will be if three or more countries are involved (instead of two countries).

If a taxpayer has branches in several countries, a proportion of a potential recovery limitation in this respect can probably be avoided by directly incurring the costs in the country of the establishment where the costs are used locally. If in instant case, the costs had been incurred directly in the United Kingdom, where turnover was generated from local customers, no double test would have been involved. 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 EU VAT Implementing Regulation applying as of July 2011 stipulates that, as a starting point, the nature of services and their use must serve as the basis for determining the establishment that is to be regarded as the customer. Cost category 1 possibly occurs less frequently, as such costs can be considered to have been purchased by the UK head office. 

Incidentally, the CJEU paid no attention to the situation when the head office and/or a fixed establishment is part of a fiscal unity. Furthermore, the impact of non-EU branches was not addressed. 

In both practice and case law, it appears that more attention is being paid to the manner in which the right to recover VAT must be calculated. This applies in a broader sense to more than just head office-fixed establishment situations. Therefore, taxpayers will want to examine the manner in which the recovery right is determined and, when necessary, perform further analysis. 

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