5 April 2015

The surprise in the UK Budget was the draft legislation which seeks to limit the deductibility of input VAT in relation to costs incurred in supporting a branch network outside the UK. The legislation will also limit deduction by a UK branch on costs of supporting a head office outside the UK. The justification given by HMRC for imposing these limitations is the CJEU ruling in Le Crédit Lyonnais Case C-388/11, the judgment in which was given as long ago as September 2013.

The CJEU had suggested that even if input VAT was incurred in one country on costs which supported trading by a branch in another country, the turnover of the branch could not be taken into account in justifying VAT recovery outside the branch country. HMRC appears to be applying the principles of the judgment more widely, stating that not only the turnover must be ignored but the entire attribution or allocation of input VAT to that branch’s supplies. The principle of “use” of input VAT is thereby rendered null and void.

In their budgeting, HMRC appears to have determined that this will bring in an additional £100m per annum of tax, and almost all of this will be from the insurance and banking sectors. However, it is not clear that they have appreciated this is also a benefit for certain businesses. An insurance company with a branch network around the EU alone will be able to identify input VAT incurred in the UK but allocated to the support of branches, and recover it at their residual rate. Currently they may be forced to block this input VAT entirely, on the basis that all of the branch turnover is within the EU and therefore exempt.

In our view, HMRC will need to amend the draft legislation before it becomes law, but if they do not there may be a windfall for companies with a mainly EU branch network. Either way, it is intended that the new rules will become effective from the first tax year commencing after 1 August 2015 which for most insurance companies will be the calendar year 2016. If the law is implemented unchanged a retrospective claim may be possible for the last four years. A review of the VAT position of branch networks is urgently required.