Mergers and acquisitions – don’t forget the VAT

As autumn approaches, many corporate groups’ thoughts may be turning to optimising their business structure for the future.    

Buyers often incur substantial amounts of VAT in the course of a corporate finance transaction, but establishing entitlement to recover it as input tax is not always straightforward, with HMRC generally taking an aggressive approach when scrutinising the recovery of VAT incurred on deal fees.  

While VAT may not be the first thing on your mind when planning to expand your business, it is important to consider the structure of any significant corporate finance transaction in advance to maximise the recovery of VAT on associated costs. 

Recovering VAT on deal fees – the basics

VAT incurred on deal fees can usually only be recovered where the underlying costs are directly attributable to onward taxable supplies. Simply holding shares to receive dividends or to sell them for a capital gain is not an economic activity for VAT purposes and so does not, by itself, create a right to VAT recovery. Also, the deal costs are often incurred not by a trading entity but by a holding company or special purpose vehicle set up to acquire the target, making it more difficult to demonstrate a direct connection between the costs and a taxable business activity.

In its current guidance, HMRC accepts that there may be scope to recover VAT incurred on a share acquisition:

• ‘when the shareholding is acquired as a direct, continuous and necessary extension of a taxable economic activity of the holding company, for example acquiring a direct competitor, a similar or complementary business or a key supplier/customer with a view to increasing market share, or a company whose main asset is a property from which the holding company or other group companies intends to trade .’
• ‘where there is genuine economic business activity between the holding company and the target subsidiary company, for example a management services agreement between the entities.’

HMRC’s challenges to deal costs recovery often focus on whether a supply of management services has taken place following an acquisition, in particular whether a management charge is actually payable by the acquired entity in exchange for services provided to it by the acquiring company. HMRC’s current view is that there is no economic activity for VAT purposes where payment of management charges is contingent, for example upon the future profitability of the acquired entity.

It is also important to check that deal costs have been invoiced to the correct recipient. While a deal is in its planning stage and the acquisition vehicle has yet to be created, it is common for initial deal fees to be invoiced to the shareholders, who may not be VAT registered. In addition, it is common for buyers and sellers in a transaction to meet the costs of shareholders or other stakeholders in the transaction. HMRC may try to block VAT recovery on the grounds that the supply has not been made to the entity that ultimately pays the fees. Therefore, it is important to review (and in some cases novate) contracts with advisers as appropriate.

Consideration should also be given to whether VAT should be charged at all on particular fees incurred in the course of a deal. Where a corporate finance adviser brings together a buyer and a seller to engage in a share deal, that adviser’s fee may qualify for VAT exemption if it can be established that it acts as an intermediary in a sale of VAT exempt shares. It is important to check this with your corporate finance advisers – if no VAT is payable on the fees, this reduces the amount of VAT that could be vulnerable to an HMRC challenge on its recoverability.

Recent legal developments

The eligibility of holding companies and other acquiring entities to recover VAT, both on deal fees and other costs, has been the subject of several strands of case law in the UK and European courts recently, so it is essential to confirm that you have taken account of the latest developments.

In an appeal brought by Norseman Gold, the Upper Tribunal upheld HMRC’s decision to disallow VAT recovery of £81,000 on holding company costs, finding that the written management services agreement between the acquiring entity and the acquired business only demonstrated a ‘vague intention to levy an unspecified charge, at some undefined time in the future’. Therefore, as there was no firm consideration payable, Norseman Gold had not made a taxable supply of management services and could not recover the VAT as input tax because it had no business activity for VAT purposes.

In contrast, the tribunals have found in favour of the taxpayer in more recent appeals brought by Tower Resources PLC and Bluejay Mining plc. These decisions were broadly supportive of arguments that adding agreed management charges to an intragroup loan account, which was repayable on demand, could constitute consideration for the supply of management services. HMRC has recently decided not to appeal these decisions further, but at the time of writing has not made any statement on their impact on its overall policy.

The UK is also still bound by European case law concerning recovery of VAT on abortive transactions. In a 2018 judgement, the Court of Justice of the European Union (CJEU) found that Ryanair was entitled to recover VAT on the costs of a deal that did not complete as planned, because at the time it incurred the costs, it had a firm intention to provide VATable management services to the target entity in the event of a successful takeover. However, the limits of this finding have been tested in a subsequent case where the CJEU found that VAT incurred on raising funds for what proved to be an abortive transaction was not recoverable in a case where the funds intended for that transaction were used to make VAT exempt loans instead – the court ruled that it is the actual use of the funds in respect of which costs were borne, rather than an intended use, that determines the right to VAT recovery.

Although the courts have recently been more sympathetic to VAT recovery than they have been in the past, this does not give a simple green light for holding companies to recover all of the VAT they incur on deal costs or other related expenses. HMRC is still actively challenging eligibility to recover VAT incurred in connection with corporate finance transactions, so it is essential to consider the VAT position at every step of the transaction and set up robust agreements to protect your position.

For more information please get in touch with Philip Munn.