To "VAT be" or "not VAT be", that is the "VAT question"

On 16 July 2009 the European Court of Justice announced a decision which simplifies the recovery of VAT in relation to expenditure incurred by an entity operating through fixed establishments in other Member States.

The ECJ has ruled, in Commission of the European Communities v Italian Republic, Case C-244/08, that, subject to national rules, a taxable person having a fixed establishment in one Member State is regarded as established in that Member State, and can apply for the deduction of the VAT incurred on purchases made in that Member State, whether the purchases are effected through its fixed establishment, or directly by its principal or head office establishment wherever established, i.e. in another EU Member State or outside the EU.

The Case

The European Commission commenced infraction proceedings against Italy, which had effected a rule that where a Principal or Head Office established outside of the Italian Republic, incurred costs in relation to a branch with a fixed establishment in Italy, it could only make a claim for recovery of input VAT using the 8th or 13th Directive procedures, which are normally for use by non established EU and non EU operators respectively.

The Commission argued that this procedure breached the conditions in those directives, since the condition for eligibility to claim under those Directives was conferred upon “taxable persons not established in the territory of the country” or “taxable persons not established in the territory of the Community” respectively. Thus the normal rules under article 18 of the 6th Directive should apply in respect of a fixed establishment, however the expense was incurred.

The Judgment

In a well reasoned judgment, Judge T von Danwitz, rapporteur for the Eight Chamber, upheld the approach of the Commission. He stated first that the old Article 17 of the VAT 6th Directive set out the rules on deduction according to the single criterion of place of establishment. A taxable person established in Italy was therefore entitled to deduct VAT on their expenses, whether or not these were incurred by that establishment, or by its principal establishment.

Flowing from article 17(4), the right to refund was further extended to taxable persons not established in the Member State where the expense was incurred, by the 8th Directive to those established in another EU Member State, and by the 13th Directive to those not established within the EU.

To adopt the Italian procedure would create a third category of taxable person, a person who although established in the territory of the country, would not be entitled to a right of deduction of VAT.

Moreover, even if there were difficulties, the VAT system already took these into account, for example the recovery rate in the territory of establishment would be used in cases where both taxable and exempt supplies were made; see Monte dei Paschi di Siena, case C-136/99.

As it did in the case of FCE Bank, Case C-210/04, the ECJ has decided that the principle of legal personality trumps any issues of territoriality.

Practical Steps going forwards

Businesses should examine whether they have incurred VAT on expenses at Head Office level in respect of a branch (i.e. the same legal entity) in another Member State, and in relation to which they have not claimed VAT. Under EC v Italy, they should be eligible to make these claims through the local establishments, at the local recovery rate.

Where trading has not commenced in the local establishment, it is important to put in place projected budgeted figures so that a planned recovery rate can be determined. Under principles established in Rompelman, Case 268/83, it should be possible to make refund claims on this basis.

How can CMS help?

We have been assisting clients making claims, usually for Head Office expenses in the set up and oversight of a local branch in another EU member state, whether or not the local branch has commenced trading or not. Given there are stringent limitation periods in some member states, businesses should examine their set up, management or closure costs for overseas branches which have been expensed at Head Office level, and make outstanding claims for VAT as soon as possible.

As the English version is not yet available from the ECJ, we have prepared a draft translation of the judgment. For a copy or for further details as to how we may help you, please contact: