The issue of how much VAT incurred in connection with corporate mergers, acquisitions or restructuring can be recovered has been one of VAT’s longest running disputes between businesses and HMRC. A recent development in appeals before the European court could now force HMRC to radically change its policy – presenting some companies with an opportunity to reclaim VAT paid on deal costs incurred in the last four years.
HMRC’s policy has long been that where costs are incurred by an entity whose main objective is to hold the share capital of its subsidiaries or its acquisition target (Holdco or Bidco), VAT incurred on those costs is not recoverable on the basis that the business has not undertaken any ‘economic activity’ of a type which would allow the recovery of VAT. Following its success in the BAA case HMRC confirmed this position, advising that it even extended to circumstances where a Holdco or Bidco has been included in a VAT group registration along with its acquisitions.
Although HMRC’s position has been slightly more relaxed in circumstances when Holdco or Bidco has evidenced an intention to recharge deal costs or otherwise make management charges to the companies in which it holds investments, it has increasingly sought evidence of the capability of the Holdco to provide such services, evidence of the services taking place, and that the acquisition costs incurred relate to such charges. As a result, there has been a consistent risk that VAT can constitute a significant and unwelcome additional cost to a deal.
The European angle
The issue of the recovery of VAT in this area is not limited to the UK; it has been a problem throughout the European Union and has led to taxpayers seeking to have their appeals referred to the European Court of Justice. A recent development in appeals before the European Court could now, however, force HMRC to radically change its policy.
In the joined cases of Larentia + Minerva and Marenave, the European Court ruled that the recovery of VAT on deal costs should be determined by reference to the wider economic activities of the Holdco or Bidco as a whole and not, as HMRC believed, solely by reference to narrowly defined charges intended to recoup deal costs.
In principle, this decision suggests that the proper approach to determining VAT recovery should be that where a separately VAT registered holding company makes, or intends to make, management or administrative charges to its acquisitions or subsidiaries, VAT incurred on underlying costs should be recoverable in full on the basis that it relates wholly to the onward VATable management or administrative charges.
If the acquisition or subsidiary join a VAT group registration with the holding company, VAT incurred by the holding company would be seen as an overhead of the VAT group as a whole, and recoverable to the same extent as any other VAT incurred on any other overhead.
What does this mean for the future?
The decision of the European Court is a clear indication that HMRC’s approach is wrong and it is noticeable that, even before the European Court’s decision was issued, HMRC had indicated that it would review its policy. The decision of the European Court is now likely to result in a dramatic revision to HMRC’s policy and guidance.
The important point for businesses which have previously suffered a restricted VAT recovery is that the European Court’s decision, and expected change in HMRC policy, will give rise to the prospect of claims for the refund of VAT historically under-recovered or disallowed by HMRC.
Moving forward, businesses which are either planning, or are in the process of, a corporate finance transaction will have the opportunity to structure deals in a VAT efficient manner.
What can you do to recover VAT?
- Where there is an existing VAT refund claim submitted to HMRC or subject to an appeal before the UK Tax Tribunal there is cause for optimism. Now is a good time to undertake a detailed review of the technical aspects of the VAT reclaim in anticipation of HMRC conceding that a VAT refund might be due.
- For businesses which have suffered any restriction of VAT recovery on deal costs in the last four years, either as a result of accepting HMRC’s policy or by being subjected to and required to pay a VAT assessment issued by HMRC, it is open to them to submit a VAT reclaim to HMRC. Clearly, it is important that any such VAT reclaim is properly formulated and supported by appropriate back-up documentation. If any VAT assessment also resulted in HMRC assessing for penalties and interest, a claim should seek that these are also repaid. It may also be appropriate in some instances to submit a claim for financial restitution in the form of statutory interest.
- For new transactions, the opportunity exists to structure the VAT aspects in a way which gives the best possible prospect of VAT on associated costs being recoverable. As is always the case with VAT, this is best done at the planning stage to ensure that appropriate entities and VAT registrations are in place, and that appropriate adviser engagements can be established at the outset.
If you require further information or would like to discuss this further, please do not hesitate to contact your usual RSM VAT adviser, Steve Jacob or Ian Carpenter or one of our Transaction Taxes team.