A recent tribunal decision has highlighted the importance of correctly valuing management charges to connected entities for VAT purposes, especially when the recipient is not entitled to recover VAT in full on the cost.
The Jupiter Asset Management case
Jupiter Asset Management is a large fund management business whose corporate group includes two separate VAT group registrations: asset management (AM) and investment management (IM). AM provided management services to IM, largely representing the work of executive directors employed by AM who also worked on wider group matters, but also for non-executive directors and related legal and professional fees.
AM charged VAT on the management charges that IM, a financial services business, was not entitled to recover in full. However, HMRC took the view that AM had undervalued the charges and issued a VAT open market value direction plus assessments for output VAT of £2m it believed had been underdeclared on the management services provided.
AM appealed, claiming to have priced the services at arm’s length in accordance with transfer pricing principles, but the First-tier Tribunal (FTT) has upheld HMRC’s assessments, broadly agreeing with HMRC’s cost based approach to the valuation of the management charge for VAT purposes. The FTT concluded that HMRC’s methodology reflected the relevant legislation and that AM had not provided sufficient evidence to support its arm’s length approach or otherwise show that the assessments should be reduced.
Principles for valuation of management charges
The FTT made the following findings on how management charges should be valued for VAT purposes.
- Management services provided within the same corporate group cannot generally be valued by comparison to transactions between unconnected parties, as it is not usually possible to identify arm’s length transactions that are directly comparable with the actual transaction , so they must instead be valued using a cost method under which the value of the management charge is not less than the full cost to the supplier providing the management services.
- Although a cost based method may in practice result in the same valuation when comparing the price of a supply to a similar transaction between unconnected parties following the arm’s length principles set out in the OECD Transfer Pricing Guidelines, the arm’s length and VAT open market value concepts are different concepts and arm’s length valuations have no relevance for VAT purposes where there is no directly comparable actual transaction .
- The costs of executive directors and other staff who provide management services form part of the cost of providing those services, so the supplier must distinguish between its director, staff and other costs that specifically relate to the supply of management services and those relating to other matters. The relevant directors’ and staff remuneration should be analysed on a time spent basis to determine how much time is spent performing the services and how much on other activities.
How does this affect intra-group charges in general?
This appeal takes a detailed look at how a complex management charge between connected companies should be valued for VAT purposes and also highlights how difficult it can be to identify and value directors’ time that is specifically spent on managing subsidiaries. In this case, there was a very big difference between the taxpayer’s valuation and HMRC’s view, which has resulted in a large irrecoverable VAT bill for the taxpayer.
The Jupiter Asset Management decision also emphasises the different approaches to valuing intra-group charges for VAT and direct tax purposes, with the FTT dismissing the suggestion that the arm’s length principle applies for VAT purposes in all circumstances. The risk of irrecoverable VAT means it is important to correctly identify and value management charges between connected entities within the UK. This is a particular issue in any sector where the recipient is partly exempt (eg a financial services business) or a non-business organisation (eg a charity) which cannot recover all the VAT it incurs on costs.
The decision is also a reminder to review the VAT position of intra-group recharges from time to time in case they constitute consideration for a supply of services. In some circumstances, it may be possible to use other HMRC VAT concessions on salaries of common directors to value a management charge more accurately.
Management charges should also not be overlooked when calculating taxable turnover to decide whether an entity is required to register for VAT. Even if the entity has no other VATable activity, taxable management charges are often enough to exceed the VAT registration threshold in their own right.
For more information please get in touch with Philip Munn.