The Court of Justice of the European Union (CJEU) has firmly rejected the right of a French bank to deduct input tax according to the turnover from supplies made by its branches in other countries, in Le Credit Lyonnais (2013) Case C-388/11.

The CJEU’s judgment reads:

  • Article 17(2) and (5) and Article 19(1) of the Sixth Council Directive 77/388/EEC of 17 May 1977 on the harmonisation of the laws of the Member States relating to turnover taxes – Common system of value added tax: uniform basis of assessment, must be interpreted as meaning that, in determining the deductible proportion of VAT applicable to it, a company, the principal establishment of which is situated in a Member State, may not take into account the turnover of its branches established in other Member States.
  • Article 17(3)(a) and (c) and Article 19(1) of the Sixth Directive 77/388 must be interpreted as meaning that, in determining the deductible proportion of VAT applicable to it, a company, the principal establishment of which is situated in a Member State, may not take into account the turnover of its branches established in third States.
  • The third subparagraph of Article 17(5) of the Sixth Directive 77/388 must be interpreted as not permitting a Member State to adopt a rule for the calculation of the deductible proportion per sector of business of a company subject to tax which authorises that company to take into account the turnover of a branch established in another Member State or in a third State.

Le Credit Lyonnais (LCL) initially deducted its French VAT for the late Eighties on the basis that it should be allowed to include interest received by the French Head Office from loans made to its branches outside France.  This was refused by the French tax authority on the basis that there is no supply between a Head Office and its branch, and LCL accepted that.  Alternatively, LCL suggested that it should be allowed to take into account the turnover of the foreign branches in calculating its deductible proportion in France.

The CJEU has found that such turnover must not be taken into account, and that a Member State is not permitted to introduce law to allow such a calculation.  This is despite the fact that input tax may be incurred in France on goods or services which are used to make supplies from those branches.  Thus, a business may have structured itself to carry out back office servicing at its Head Office for products sold in all its branches, but it will only be allowed to enjoy input tax deduction on the basis of its turnover from the Head Office. 

If the non-EU turnover is dealt with from the Head Office, and only EU turnover from the branches, this may lead to an unfairly high deduction.  On the other hand, if mainly EU turnover is dealt with at the Head Office and the branches are all generating non-EU turnover the deduction by the Head Office will be unfairly low.  The CJEU suggests that this would not offend the principle of fiscal neutrality as the company has the right to choose whether or not to have a branch.  If there is no branch then the turnover would all be turnover of the Head Office and taken into account.

The CJEU does not appear to have considered the fact that input tax incurred in one country may be used to make supplies from a branch in another country.  For this reason the judgment is regressive.

The extent of this ruling is not entirely clear as the result sought by LCL may be achievable in some Member States by other means, but it may lead to changes in Member States as regards the partial exemption methodology allowed.  In the UK HMRC generally applies a rule that foreign turnover must be ignored, but  for insurance companies it has allowed foreign turnover to be taken into account if there is UK input tax used in making the foreign supplies.  In future this may have to be achieved in a different way unless HMRC decide to change their policy to exclude such treatment altogether.

Whether LCL’s interest charges to branches should be taken into account was a question not dealt with by the CJEU, as the French Conseil d’Etat did not ask the question.  The earlier case of FCE Bank (2006) Case C-210/04 appears to decide the matter.  Further light may be thrown on this (in the context of VAT groups at least) by another case to be heard by the CJEU – Skandia America Corporation Case C-7/13 – but no hearing date has yet been set.  Since VAT grouping is not allowed in France, LCL may not benefit from any ruling that there is a supply between Skandia America’s Head Office and its branch in Sweden.

If you have any questions regarding the above, please do not hesitate to contact Peter Hewitt CTA (Fellow), Client Director on t: +44 (0)20 7036 8070 | e: peter.hewitt@fiscalreps.com