Valuation of management charges for VAT purposes: transfer pricing and VAT diverge?

A 2021 tribunal decision highlighted the importance of correctly valuing management charges to connected entities, 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: Jupiter Asset Management Group (JAM) and Jupiter Investment Management Group (JIM). JAM provided management services to JIM under a Management Services Agreement (MSA). The services were largely provided from the work of executive directors who were employed by JAM, but also worked on wider group matters. JAM also incurred costs from non-executive directors and legal and professional fees related to its management of JIM. 

JAM made management charges to JIM under the MSA on which it charged VAT that JIM, a financial services business, was not entitled to recover in full. However, HMRC took the view that JAM had undervalued the management charge to JIM and issued a VAT open market value direction plus assessments for output VAT of £2 million it believed had been underdeclared on the management services. 

JAM appealed, claiming to have priced the services at arm’s length value in accordance with transfer pricing principles, but the First-tier Tax Tribunal (FTT) has upheld the assessment, broadly agreeing with HMRC’s cost based approach to the valuation of the management charge. Although the FTT suspected that the costs calculated by HMRC may not be completely accurate, it preferred HMRC’s methodology as JAM had not provided sufficient evidence to support its arm’s length argument or otherwise show that the assessment should be reduced.

The FTT also made the following notable findings on how management charges should be valued for VAT purposes:

• Management services provided within the same corporate group cannot be valued by comparison to transactions between unconnected parties, so 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 service.
• The concept of ‘arm’s length price’ (in the OECD Transfer Pricing guidelines) is relevant only to direct tax and does not apply to VAT. Although it may in practice result in the same valuation when comparing the price to a similar transaction between unconnected parties, arm’s length and open market value are not the same and the concept of arm’s length has no relevance at all in a situation like JAM’s when open market value must be determined by the cost method as there is no effective comparator.
• The costs of executive directors who carried out the supplies of management services form part of the cost of providing the service, so JAM needed to distinguish between its director costs that specifically related to the management services to JIM, and those that related to other Jupiter group matters. The directors’ remuneration should be analysed on a time spent basis to determine how much time was spent performing the services under the MSA and how much on other activities.

How does this affect intercompany 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 JAM’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 intercompany charges for VAT purposes and for direct taxes, with the FTT quickly dismissing any suggestion that VAT falls within the arm’s length principle. Unlike transfer pricing, which concerns cross border intercompany charges, for VAT it is just as 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 a partly exempt company (e.g. a financial services business) or a non-business organisation (e.g. a charity) which cannot recover all the VAT it incurs on costs.

The decision is also a reminder to review the VAT position of intercompany 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.

These 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, Sarah Halsted, or your usual RSM contact.