The Supreme Court has ruled on the treatment of the costs incurred by Hotel La Tour Ltd (HLT) related to its VAT-exempt disposal of shares in a subsidiary (Hotel La Tour Birmingham Ltd). HLT lost its appeal. It cannot recover the VAT on these costs, even though the sale proceeds would be used to fund its taxable business activities – the management of a new hotel in the group.

HLT failed to establish that the costs could be linked to its overall business and therefore recovered. However, the court did not confirm that all transaction costs would automatically relate to an exempt supply. In any transaction, each cost must be reviewed to determine whether it has a direct and immediate link to the share sale.

In short, the judgment leaves businesses without a clear rule for recovering VAT on transaction-related costs.

What did the Supreme Court decide on VAT recovery?

The Supreme Court reflected on those tests that have been established in previous cases.

First, it observed that the ‘direct and immediate link’ test for input tax recovery, does not need to be direct, ie the closest link to a particular output, nor does it need to be immediate – the output may be in the distant future.

Second, it was not possible to determine whether the costs in question were a ‘cost component’ by reference to the price of a supply. This matters because previous rulings suggested that, because the value of the share sale was not linked to the cost of the fees, those fees could not be a cost component of the sale.

Active vs passive holding companies – why status matters

Despite these reservations about fundamental VAT concepts, the Supreme Court provided certainty on some key points.

The sale of shares by a holding company that supplies management services to its subsidiaries is exempt from VAT. In contrast, the sale of shares by a passive holding company (that only earns dividend income) is outside the scope of VAT.

The court rejected HLT’s argument that it would be unfair (a breach of fiscal neutrality) for input tax recovery to depend on the holding company’s status. In making this assertion, HLT relied on the European Court’s (CJEU’s) judgment in SKF (Skatteverket v AB SKF, Case C-29/08). The Supreme Court responded on this point to explain that the CJEU had not eroded the distinction between active and passive holding companies.

Lady Rose stated:

“I do not read SKF as assuming that inputs assisting a share sale which is out of scope or exempt will always be treated as directly and immediately linked with the overall business. What SKF decides is that one does not argue backwards from the fact that the share sale is within scope but exempt in order to conclude that the inputs must be directly and immediately linked with the share sale. In so far as HMRC made that submission in this appeal then I do not accept it. One must still argue forwards from an analysis of the connection between the inputs and the share sale to decide whether they are directly and immediately linked to that sale or to the general business. If they are directly and immediately linked to the share sale and the share sale is exempt then the inputs are not deductible. If they are not directly and immediately linked to the share sale but to the general business then the inputs may be deductible in whole or in part depending on the tax status of that general business.”

Tracing sale proceeds – why purpose is not enough

The court also played down the relevance of HLT’s purpose in selling the Birmingham hotel. HLT might have been able to demonstrate that the funds were needed to build a new hotel in Milton Keynes and that it would generate taxable turnover from managing it. But in most cases, tracing which project the proceeds of a share sale will fund would create confusion – or, even worse, invite companies to manipulate their accounts.

The purpose of a transaction may help identify a direct and immediate link when there is a significant time lag between a cost and a supply. Beyond that, it is generally not relevant.

Can VAT still be recovered on transaction costs?

HMRC initially denied input tax recovery of £76,823 on transaction costs on the basis that HLT had no economic activity. The dispute only later focused on direct and immediate links.

On the back of positive results in the First-tier Tribunal (FTT) and Upper Tribunal, HLT would have been entitled to full VAT recovery. The Court of Appeal, now endorsed by the Supreme Court, reversed those rulings, leaving HLT with no VAT recovery at all. From the outset, the case has proceeded on an all-or-nothing basis.

The principal costs under consideration were £255k charged by Jones Lang Lasalle (marketing agents) and £115k by Shoosmiths (lawyers). However, there is only limited detail on the precise services provided. Under the share purchase agreement, HLT agreed to sell the shares for £4.8m but also required the purchaser to ensure the company repaid a £12.1m loan to HLT, and a £13.5m loan to Coutts.

There was no consideration of whether advice and assistance on the outstanding loans should be treated as separate activities, possibly linked to HLT’s overall business. The costs were simply grouped with other costs relating to the share sale.

The FTT observed that the costs were ‘part of the process’ of selling the shares and were ‘used’ in the fundraising transaction. These statements were seized on by the Court of Appeal as evidence of a direct and immediate link to an exempt share sale. This made any further findings of fact, and any need to remit the appeal to the FTT, unnecessary. However, the FTT made these remarks briefly as, in its view, they did not inhibit VAT recovery. It perhaps conceals that a detailed review of the costs would have established some entitlement to VAT recovery.

Practical steps for businesses planning share disposals

This is unfortunate for HLT but sets out the right approach for others. In projects leading up to the sale of shares in a subsidiary, businesses should:

• Consider the phases of the project. At some point, it may become clear that a share sale will take place. Until then, advice received may be strategic and so not be directly linked to a share sale.
• Consider the scope of the transaction services. Are all of them directed at selling the shares? Or are some of the services being provided in parallel and are they more clearly linked to the business as a whole? How is this reflected in engagement letters and supplier invoices?
• Check that VAT is being charged correctly. If a marketing agent assumes the status of lead adviser in a transaction that will clearly result in a share disposal, is it providing exempt financial intermediary services?

The Supreme Court’s judgment has laid to rest any expectation of automatic VAT recovery on share disposals by fully taxable companies. However, with the right circumstances and supporting documentation, some VAT recovery should not be controversial.

If your business is planning a share disposal or reviewing VAT recovery on transaction costs, our VAT specialists can help. Get in touch with Phillp Munn for more information.

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