29 March 2019
Although a fixed establishment and its head office qualify as one VAT taxable person, the turnover of both establishments cannot systematically be combined to determine the right to VAT deduction in the country of the fixed establishment and/or in the country of the head office, says the European Court of Justice.
The European Court of Justice had previously already ruled that the transactions of foreign establishments cannot systematically be included in the pro rata in the country of the head office (C-388/11). Recently, the European Court of Justice has also clarified how the VAT deduction rules need to be applied in the country of a fixed establishment (C-165/17).According to this case law, it is necessary to determine on a case-by-case basis to which extent the turnover of the fixed establishment and/or that of the head office in another country can be taken into account.
According to the Court of Justice, the right to input VAT deduction of a cost must be evaluated in view of the outgoing transaction to which it relates, regardless whether this transaction is performed by the head office or the fixed establishment. If there is an exclusive link with a transaction that gives rise to a right to deduct VAT, then the VAT on this cost is fully deductible. If the cost exclusively relates to a transaction that does not give rise to a right to deduct, no VAT deduction is allowed.
For mixed costs – being costs that are used for both transactions that give rise to a right to deduct VAT and transactions that don’t – the VAT is only deductible according to a pro rata. But how should this pro rata be determined if a fixed establishment incurs costs which are only used for transactions of the head office and other costs which are used for both transactions of the head office and those of the fixed establishment itself?
Note that the underlying facts of this case (C-165/17) took place before the VAT package was introduced. Since the introduction of article 22 of Implementing Regulation nr 282/2011, it is however less likely that a fixed establishment incurs VAT in relation to services that also relate to other establishments.
If a fixed establishment incurs mixed costs that only relate to transactions of the head office, a specific pro rata must be used which only takes into account the transactions of the head office.
If a fixed establishment incurs mixed costs that relate to both transactions of the head office and those of the fixed establishment (‘overhead costs’), a pro rata should be used which takes into account both the transactions of the head office and those of the fixed establishment.
In this case, the European Court of Justice did not address the situation where the mixed costs only relate to the transactions of the fixed establishment, but if we follow the same line of reasoning, only the transactions of the fixed establishment should then be included in the pro rata.
A fixed establishment may therefore need to apply 3 different pro rata’s for its mixed costs, and this can be a real challenge. The fixed establishment must not only make sure that it applies the ‘correct’ pro rata to the relevant costs, but it must also be able to prove in case of a VAT audit that a particular cost effectively relates to the transactions included in the applied pro rata.
Note that the European Court of Justice also nuanced its previous case law on the VAT deduction in the country of the head office (C-388/11). In this case, the Court had ruled that the turnover of the foreign fixed establishment should not be included in the pro rata of the head office. According to the European Court of Justice, this conclusion was mainly based on the fact that in the case at hand a part of this turnover was not related to these costs. In other words, the above principles could also be applied ‘mutatis mutandis’ when evaluating the right to deduct VAT of the head office.
In principle, the following transactions give rise to a right to deduct VAT:
If the transactions of the foreign head office are included in the pro rata of the fixed establishment, the numerator will specifically include the transactions of the head office that would give rise to VAT deduction if they had been carried out in the Member State of the fixed establishment.
Some transactions are however subject to an ‘optional’ VAT regime; i.e. transactions which are in principle exempt from VAT and do not give rise to a right of deduction, but for which the supplier may – under certain conditions – opt to apply VAT anyway. In that case, these transactions do give rise to VAT deduction. These optional schemes are however governed by national legislation and vary from country to country. According to the European Court of Justice, it is important to verify whether the taxable person has exercised this option in the country where the input VAT was incurred, in order to determine if the transactions give rise to the right to deduct VAT in accordance with the third bullet point.