Out-Law Legal Update | 10 May 2017 | 1:13 pm | 4 min. read
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.
There are two main conditions for the recovery of VAT:
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 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.
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.