HMRC guidance on VAT recovery for holding companies

The issue of VAT recovery by holding companies in relation to corporate transactions has always been a bit of a minefield. HMRC has taken a tough line and there have been a number of cases. VAT recovery was denied in cases such as BAA, African Consolidated Resources and Norseman Gold. In 2015 the CJEU decisions of Larentia + Minerva and Marenave were more favourable to taxpayers, as was the 2016 FTT case of Heating Plumbing Supplies. These decisions were not consistent with the view previously taken by HMRC, but it has taken until now for HMRC to issue revised guidance, in the form of an update to its VAT Input Tax manual.

Background

There are two main conditions for the recovery of VAT:

• the VAT must be incurred by a taxable person in the course of an economic activity; and
• the goods and services on which the VAT is incurred must have a direct and immediate link with taxable supplies made by that person.

Demonstrating that the VAT is incurred in the course of an economic activity can be more difficult for holding companies than for trading companies. Passive activities such as simply holding shares in order to receive dividends and ultimately to sell them for a capital gain is an investment activity and so is not treated as an economic activity for VAT purposes. For the VAT to be potentially recoverable a company acquiring the shares must do so for some other purpose which is economic. This could be an activity of trading in securities, but for holding companies is more likely to be acquiring and holding shares in subsidiaries to which the holding company intends to provide management services for consideration.

HMRC's policy used to be that VAT incurred on the costs of acquiring shares by a holding company was only deductible where it was directly attributable to the provision of taxable management or technical services. VAT incurred had to be apportioned between non-economic activity of shareholdings and economic activity. Additionally, HMRC took the view that VAT on costs incurred by a holding company was only recoverable if the intention was to recoup the expenditure from the income resulting from taxable services provided to subsidiaries within a reasonable time.

In Larentia+Minerva the CJEU held  that VAT incurred by a holding company on the costs of acquiring shareholdings in subsidiaries, to which it also intends to provide taxable management services, must be regarded as belonging to the holding company’s general expenditure. This means that the input tax should be deductible subject to any partial exemption restriction.

New HMRC guidance

HMRC's new guidance confirms that in order to be able to deduct VAT incurred on costs of acquiring shareholdings in subsidiaries the following conditions must be satisfied:

• the holding company making the claim must be the recipient of the supply – HMRC considers this is satisfied where the holding company has contracted for the supply, including by novation, and it has made use of the supply, been invoiced and paid for the supply.
• the holding company must be undertaking economic activity for VAT purposes – this will be satisfied where the holding company makes or intends to make supplies of management services for consideration, to its subsidiaries.  The management services must be genuine and provided for a consideration which is more than nominal. Full recovery may not be possible if management services are not supplied to all the subsidiaries.
• the economic activity must involve the making of taxable supplies - the holding company should create and retain contemporaneous evidence of its intention to make taxable supplies. Full recovery may not be possible if as well as providing management services, the holding company makes exempt supplies in providing loans to the subsidiaries. However, the HMRC guidance now confirms that where the holding company is lending money to companies within a VAT group and these loans can be seen to support the making of taxable supplies by the VAT group, the related VAT will be recoverable to the extent that the costs support taxable supplies made. This is the case whether the transactions within the group would be taxable or exempt supplies, were they not disregarded because of the VAT grouping.

The HMRC guidance flags that there could still be a problem with VAT recovery where the payment for management services is contingent upon the profitability of the subsidiaries.

Shareholding as extension of taxable economic activity of the holding company

If the shareholding is acquired as a direct, continuous and necessary extension of a taxable economic activity of the holding company, the VAT incurred may also have a direct and immediate link to taxable supplies and be recoverable, even if the holding company does not supply management services to the acquired business.

Examples could include where a company acquires a subsidiary whose main asset is a property from which the retail company intends to trade. Another example given by HMRC is where a business acquires a direct competitor, a similar and complementary business or a key supplier/customer with a view to increasing market share, achieving economies of scale, or achieving efficiencies through greater integration of its supply chain.

Costs incurred by the target

HMRC also confirms that the VAT on costs incurred by the target of an  acquisition,  such as vendor due diligence costs, may also be deductible provided it can be shown that the target is the recipient of the supplies in question and those supplies were received for the purposes of the business carried out by the target.  

Practical steps

HMRC's guidance is helpful, and will enable VAT recovery in many circumstances. However the golden rule remains that VAT recovery should be considered as early in a transaction as possible. This then enables supplies to be made to the correct party and for intentions to supply management services to be properly documented and then fully implemented.