HMRC provides guidance on when holding companies can recover VAT

In new guidance HMRC outlined the strict conditions that must apply before holding companies can recover VAT. It explained that holding companies that hold shares in or on behalf of subsidiaries may be able to recover VAT depending on the purpose of the shareholding.

"Simply holding shares in order to receive dividends and perhaps to sell them for a capital gain is an investment activity and not an economic activity for VAT purposes," HMRC said. "Therefore the VAT on the costs of acquiring and holding shares for either of these purposes is not recoverable. For the VAT to be potentially recoverable the shares must have some other purpose which is economic."

"For example: shares may be acquired and held temporarily as part of an activity of trading in securities. Trading in securities is an economic activity. A further example is that a company may acquire and hold shares in subsidiaries in order to provide management services for consideration to those subsidiaries. The provision of services for consideration is an economic activity. However, the costs of acquiring and holding shares will not relate to an economic activity where the provision of services is ancillary to the investment activity," it said.

HMRC said it had decided to issue the new guidance in response to a Court of Appeal judgment last year. In a case involving UK airport operator BAA, the Court of Appeal ruled that VAT incurred by a holding company on a takeover was not recoverable. HMRC said the judgment did not affect its policy on that issue but said there were "other commonly encountered issues relating to holding companies" that were not addressed by the ruling which has prompted it to update its guidance.

Indirect taxes expert Darren Mellor-Clark of Pinsent Masons, the law firm behind Out-Law.com, said: "The issue of the treatment of holding companies in general and input tax recovery in particular has been a constant source of difficulty both for HMRC and the taxpayer. This guidance has been in preparation for some time, with HMRC liaising with several commercial stakeholders."

"It would appear that no account has been taken of the CJEU’s comments in the Skandia case regarding loss of individual identity when a company joins a VAT group. We would expect further discussion and updates for both this and the other cases mentioned. The story is unlikely to end here," he said.

In the Skandia case the CJEU ruled that services supplied by the US headquarters of an insurance business to a Swedish branch which was VAT grouped  with other local companies were subject to VAT. The Court said that because the branch of the US company was the member of a VAT group, it could no longer be treated as being the same legal entity as its US head office for VAT purposes. The creation of the VAT group established a new entity, for VAT purposes, which was an amalgam of all its members. This meant that the supply of services from the US head office to its branch was now subject to VAT.

In its guidance, HMRC explained that even if a holding company joins a "VAT group which makes taxable supplies", its activities may not necessarily permit it to recover VAT it incurs.

"If a holding company incurs costs which relate to non-economic (i.e. non business) activity the VAT incurred on those costs remains irrecoverable," HMRC said. "VAT may be recoverable where the holding company is engaged in economic activity and making supplies to subsidiaries within the VAT group, where the subsidiaries are making onward taxable supplies."

An example where VAT may be recoverable by a holding company is where it provides services to subsidiaries for a fee but at a cost to it but whether the subsidiary makes "taxable supplies" to others outside of the VAT group, HMRC said. It said in those circumstances, "there may be a direct and immediate link between the costs incurred by the holding company and the onward taxable supplies of the subsidiary" and that this could allow VAT to be recovered.

"The VAT on the goods and services received by the holding company and used to make supplies to the subsidiary will be recoverable to the extent that the costs incurred by the holding company are cost components of services provided by the holding company to the subsidiary and to the extent that the subsidiary uses the supplies from the holding company to make taxable supplies," HMRC said.

The fact that a holding company charges a fee for its services in that scenario does not automatically mean that there a "direct and immediate link" can be made between the VAT on the costs it has incurred in providing those services and the subsidiary's own supplies, it said.

"The fee must be for goods or services which the holding company intends to supply to the subsidiaries and the costs incurred by the holding company: must be used for the purpose of making those supplies; and must be cost components of the price of services provided to the subsidiaries," HMRC said.

HMRC also said that VAT is only recoverable "to the extent that the costs on which the VAT is incurred are attributable to taxable supplies which are intended to be made in the course of an economic activity" and not those relevant to non-economic activities.

HMRC said it may have to update its guidance again to account for two judgments expected from the Court of Justice of the EU (CJEU) in cases relevant to this area of tax law which have been referred to the CJEU from Germany. The rulings in those cases are expected within the next 18 months approximately, it said.