UK VAT recovery allowed on professional services incurred on corporate fundraising disposal

Tax expert Eloise Walker of Pinsent Masons said: “This is a welcome development, and not so specific in its facts that it is not capable of more general application.”

Hotel La Tour Limited is the holding company of a group that owns and operates luxury hotels. It decided to sell one of its subsidiaries, which ran a hotel in Birmingham, to fund the development of a new hotel in Milton Keynes. It incurred professional fees of lawyers, accountants and marketing agents on the disposal of the shares in the subsidiary. It sought to recover the VAT incurred on these fees, but HMRC refused the recovery.

The First-tier Tax Tribunal (FTT) originally found in favour of the taxpayer and the Upper Tribunal has now upheld that decision, finding the application of the law to the facts “unimpeachable”.

Tax disputes expert Jake Landman of Pinsent Masons said: "With robust FTT and UT decisions HMRC will need to carefully consider the merits of seeking permission to appeal."

A business that is itself either exempt from VAT or outside the scope of VAT that has incurred professional costs in the context of a fundraising transaction can still recover the VAT on those costs provided the following three conditions are met.

Firstly, the purpose of the fund raising must be to fund economic activity. In this case, the FTT found that the purpose of the sale of the shares was to raise money to develop the new hotel. The FTT was satisfied from the evidence before it that the business Hotel La Tour was carrying on was a VATable business and that the purpose of the funds raised from the sale of the subsidiary was to provide funds for the new business.

Secondly, the funds must actually be used for making taxable supplies, even if there is a delay between the fund raising and the taxable supplies. The FTT found that the money raised had all been used to fund the development of the new hotel, which resulted in the making of taxable supplies.

Thirdly, the cost of the services incurred – in this case, the professional fees – must be cost components of the “downstream activities”. This link between the costs and the later taxable supplies can be broken if the cost of services is incorporated into the price of the shares sold. The FTT found that this direct link had not been broken in Hotel La Tour’s case. The Upper Tribunal also noted that it “would be unusual to see such costs being reflected in the price paid for the shares in a standard share sale agreement”.

Walker said: “It would indeed be extremely unusual to see deal costs explicitly folded into the price paid for corporate shares, the UTT is certainly right there. And I suspect, given this decision, it is going to become an even more rare event.”

“The trickier condition is going to be the second one – that the resulting funds are used for making taxable supplies. In the world of hotel development, one can more easily see the link between disposal of the old and development of the new hotel. If the proceeds are used to fund employee bonuses, for example, does the causal chain extend that far? HMRC may well still look at that askance, and time – and further case law – will tell.”

The Upper Tribunal dismissed HMRC’s argument that there was a two-stage test to establish recoverability. HMRC had suggested that it was necessary first to consider whether there was an output transaction within the scope of VAT – whether taxable or exempt – to which the input costs were directly and immediately linked. Then, only if there was no such direct and immediate link, would it be permissible to consider if there is a direct and immediate link to general economic activity. The Upper Tribunal found that this was based on old European case law and that the law had moved on since then.

“Although not formally overruled, the [1996 BLP decision] can no longer be regarded as representing a complete statement of the CJEU’s jurisprudence in this area,” the tribunal said in its ruling.

This approach was modified by the CJEU in the 2010 SKF decision, and the applied by the UK Supreme Court in the 2019 Frank A Smart case. Since the FTT had applied this modified position correctly, its decision should stand, the Upper Tribunal said.

"Taxpayers should consider making protective claims now where they have not already done so in relation to recovery of input tax on professional fees relating to fundraising transactions in the last four years,” Jake Landman said.