Andrew Needham looks at VAT recovery on corporate acquisitions following a change in HMRC’s guidance.
When businesses undertake a major corporate acquisition, the normal procedure is to set up a holding company (HoldCo) to undertake the acquisition and hold the shares following the acquisition. HoldCo will incur all the professional fees and will manage the trading company, but recovering the VAT on the costs can be a problem if you do not structure the recharges correctly.
Problems with HMRC
HMRC’s view until recently was that following the Court of Appeal decision in BAA Ltd v HMRC [2013] STC 752:
‘HMRC are likely to challenge claims that the costs are to be recovered over timescales which would not allow the capital expenditure to be recouped for many years.’
HMRC’s view of the law was controversial and many tax experts disagreed with it. To obtain a refund of input VAT on transaction costs, HMRC argued that the arrangements put in place between Holdco and the target company (Target) should be commercially justifiable. If a return on capital is not expected within five to ten years, HMRC considered that the costs were incurred in connection with the passive activity of holding shares and receiving dividends, rather than in connection with any taxable activity. If that was the case, HMRC would disallow the input tax on the basis that it did not relate to a business activity.
Changed views
Following the recent judgment of the ECJ in the joint cases of Larentia & Minerva and Others, HMRC has reviewed its existing policy on the recovery of VAT on acquisition costs incurred by Holdco. As a result, HMRC has revised the guidance contained in its manuals. The inability to recover input VAT on acquisition costs can represent a significant expense for a Holdco, so publication of the revised guidance is a welcome step, although it has not been widely publicised by HMRC.
The ECJ ruled that the relevant expenditure incurred by the holding company in relation to the share acquisition was directly linked to its business and formed part of its general overheads. If the only outputs that the holding company made were taxable, it should be able to recover all of the input VAT it had suffered (irrespective of the value of the taxable services it was intending to provide to the new subsidiary).
In order for the Holdco to be able to deduct the input tax:
- the Holdco must be the recipient of the supply; and
- the Holdco must be undertaking economic activity for VAT purposes.
To establish that Holdco is engaged in ‘economic activities’ it must make, or intend to make, supplies of management services for consideration to its subsidiaries. In addition, the management services must be ‘genuine and more than nominal’. Provided these requirements are met, any VAT on acquisition costs should be deductible.
As well as being able to recover input VAT where Holdco provides management services to its subsidiaries, input VAT may also be recoverable if the shareholding acquired is a direct, continuous and necessary extension of a taxable economic activity of the Holdco.
If Holdco only provides management services to some of its subsidiaries, the costs incurred on acquisition of subsidiaries to which it does not make taxable supplies will not be deductible. According to HMRC, putting Holdco into a VAT group does not give an entitlement to VAT recovery and so Holdco must be ‘economically active’ in its own right.
Practical Tip:
If you are undertaking the acquisition of a company you should ensure that the holding company undertakes an economic activity, such as making management charges.
