Court finds VAT can’t be reclaimed on share sale costs

Overturning previous decisions of lower courts, the Court of Appeal (CoA) has decided that Hotel La Tour Limited (HLT) was not entitled to recover input VAT on the costs of selling shares in a subsidiary company to raise funds to build a new hotel. Subject to a possible further appeal, the professional fees incurred were found to have a direct and immediate link to the sale of the shares to a UK buyer, an exempt supply on which VAT is not recoverable.

Background

HLT is the holding company of a corporate group that operates a chain of luxury hotels, each hotel being owned and run by a subsidiary company. In 2015, it decided to build a new hotel in Milton Keynes, with the project to be financed, in part, by selling the group’s existing hotel in Birmingham. The shares in the subsidiary that owned that hotel were eventually sold to an unrelated buyer in 2017.

The dispute

A dispute arose with HMRC over HLT’s entitlement to recover input VAT incurred on various professional services related to the sale of the subsidiary’s shares, including the fees of its marketing agent, solicitor and tax advisers. HMRC disallowed VAT recovery on the basis that the professional services were used to make a supply of shares to a UK buyer, on which VAT is not deductible because it is a VAT exempt supply. HLT appealed to the tax tribunal, arguing that the fees were in fact the costs of raising funds to build the new hotel, which would be a taxable business for VAT purposes.

At earlier stages of the appeal, the First-tier Tribunal and then the Upper Tribunal (UT) both found in favour of HLT, deciding that the VAT was recoverable because there was a ‘direct and immediate link’ between the costs incurred and its taxable business of building, developing and the eventual management of the new hotel in Milton Keynes. According to those decisions, which relied on European case law, the VAT on fund-raising transactions may be regarded as related to the group’s future taxable activities and not solely to the exempt share sale.  

Latest decision

However, the CoA has now overturned the UT decision, supporting HMRC’s view that HLT’s deal costs had a direct and immediate link to the VAT exempt share sale, meaning that it could not reclaim the input VAT it had paid on those fees. The CoA’s reasoning is highly complex but appears to be based on the precise nature of the costs that were incurred in this case (its accountancy and legal fees), which the court considered to be highly specific to the share sale. Nevertheless, whilst the decision does not give clear examples of what costs might be eligible for input VAT recovery because they are attributable to a wider business activity, the CoA did find that it was not necessary for costs to be specifically included in the price of shares for there to be a direct and immediate link to an exempt supply of shares. 

What does this mean for other businesses?

The impact of this decision is not restricted to the hotel sector and should be considered by any business that hopes to recover VAT on the costs of selling a subsidiary to raise funds to pursue another business activity that is taxable for VAT purposes.

Having come this far, and won its argument in two out of three courts, HLT may well seek permission to appeal this decision to the Supreme Court. However, unless and until the latest decision is successfully appealed, businesses that have undertaken or are planning a similar transaction should consider the following key points.

• The latest ruling in HLT does not necessarily mean that all input VAT incurred on costs relating to a share sale is irrecoverable. Partial VAT recovery may be possible in some instances - for example, where only some of the costs relating to the sale have a direct and immediate link with the share transaction and others are overhead costs of the business. An allocation exercise on a cost-by-cost basis is recommended. 
• When agreeing engagement letters and contracts with professional services firms, it is helpful to ensure that the description of services clearly shows whether elements of the service relate to the claimant’s general business activities or relate directly to an exempt share sale. 
• The HLT decision may mean that raising finance through a share sale is less efficient for VAT purposes than raising finance through other means (such as through bank borrowing), due to the likelihood of a higher irrecoverable VAT cost on professional fees.

It is also important to note that the issue raised in this case is only one of the potential pitfalls those involved in mergers and acquisitions might encounter. All businesses, whether buying or selling, should consider their VAT position as early as possible in the planning stage of any significant transaction.  

For more information, please get in touch with Simon Atkins, Philip Munn or your usual RSM contact.