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Deductible VAT relating to foreign branches

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Budget 2015 announced a new measure, aimed squarely at banks and insurance companies, that will restrict the recovery of VAT on expenses that relate to establishments outside the UK.

In the past, financial services organisations have been able to adopt VAT partial exemption methods that allow them to 'look through' to the supplies made by foreign branches and determine their recovery in proportion thereto or to simply include the value of the branches’ supplies in their pro-rata calculation. The government has pitched this measure as implementing the CJEU decision in the Credit Lyonnais case (C-388/11). The proposed revisions to regulations 101, 102 and 103 will make clear that the income attributable to foreign branches must be excluded when calculating a turnover or use based pro-rata computation. The risk being combatted by the new rules is, we are told, that businesses could artificially increase the amount of input VAT they can deduct by 'over-allocating' overhead costs to non-EU foreign branches. It will apply to all longer periods commencing on or after 1 August 2015.

The tax information and impact note makes clear that the measures are intended to mean that 'deduction of input tax on overheads used to support activities of the foreign establishments of a business can only be calculated by reference to supplies made by that business’s UK establishments'. This arguably goes beyond what was envisaged by the CJEU in Credit Lyonnais and may be ultra vires EU law.

In Credit Lyonnais, the CJEU noted that the referring court was seeking to ascertain how, first, the deductible proportion of VAT of the principal establishment of a company established in France and, second, the deductible proportion of the branches of that company established outside that member state should be determined. However, because the dispute in the main proceedings related only to the principal establishment of the company in France, the CJEU declined to consider the calculation of the deductible proportions applicable to the branches established outside France. The CJEU also went on to consider that there was no evidence that including branch income in the calculation for the main establishment would produce a result more in keeping with the objective of the VAT Directive than calculating separate recoveries for the branches from the main establishment.

Whilst the CJEU judgment does support the position that branch turnover should not be included in the main establishment pro-rata calculation, it does not support the proposition that input VAT used to support the activities of the foreign establishments should be restricted to recovery in line with the activities of the UK establishment. It appears instead to imply that a second foreign branch computation should be performed. How overhead input tax should be allocated to that foreign establishment pot is unclear and was clearly intended to be considered by the CJEU in an appropriate future case.