HMRC has at long last published updated guidance setting out its new policy on input VAT recovery by holding companies. While there has been some welcome relaxation to HMRC’s former stance, businesses involved in merger and acquisition activity must still take positive steps to protect their VAT recovery on deal fees and other holding company costs.
The recovery of VAT on deal fees in corporate finance transactions has long been the subject of HMRC challenge - and ever changing guidance. HMRC has now issued an extensive update to the holding company pages of its VAT Input Tax internal manual, which sets out its latest position. This is the culmination of a lengthy policy review, which involved a series of extensive meetings with leading advisers, including BDO, and takes account of recent case law - most notably the 2015 European Court judgment in Larentia + Minerva.
Outline of HMRC’s new approach
It is a condition of VAT recovery that the holding company must:
- Have contracted for the supply (whether directly or by novation)
- Have used and paid for the supply, and
- Hold an invoice in its name.
Although in all cases it is necessary for a holding company to be involved in an ‘economic activity’, the revised guidance provides some clarification over whether it is also necessary for a holding company to make management charges or interest bearing loans to support its entitlement to VAT recovery. HMRC seeks to distinguish between ‘take-over’ style acquisitions and investment acquisitions. Broadly speaking, HMRC says:
- If a shareholding is acquired as a ‘direct, continuous and necessary extension’ of a taxable activity of the holding company (eg taking over a similar or complementary business or acquiring a company that owns an asset to be used in taxable trading) this would have a direct and immediate link to taxable supplies so VAT is recoverable without the need to make a management charge to the subsidiaries. (Note that although not explicitly stated by HMRC, this would appear to refer only to holding companies that are VAT grouped with their subsidiaries as a separately VAT registered holding company would presumably still have to raise management charges to support its VAT recovery, unless (perhaps) the trade of the acquired business was hived-up immediately post acquisition.)
- If that test is not met, eg because the target is acquired as an investment, the holding company must make (or intend to make) supplies of management services to its subsidiaries to which the relevant costs can be attributed. This is the case, even if the holding company is VAT grouped with its subsidiaries. A consideration must be paid for those services which is ‘genuine and provided for a consideration which is more than nominal’. Management charges where payment is contingent, eg on the future profitability of subsidiaries, will not entitle VAT recovery. If not all subsidiaries are charged, input VAT recovery must be apportioned.
HMRC has confirmed that certain on-going costs which may be invoiced to the holding company can be treated as a cost of a VAT group registration as a whole. The examples given include the general audit fees of the group, regulatory compliance, brand defence, bid defence and group legal costs. HMRC also confirms that VAT on vendor due diligence costs may be deductible provided it can be shown that the target is the recipient of the supplies in question and they were received for the purposes of the target’s business.
Impact on business
The new guidance looks at the issue of VAT recovery at a high level and it does not answer all questions about entitlement to VAT recovery on deal fees and other holding company costs. However, HMRC has clearly moderated significantly its previous position, which made VAT recovery all but impossible for many businesses involved in M&A activity. Many of the historic disputes have already been resolved as a result of this policy review.
However, there are still hurdles to be jumped to secure VAT recovery, especially for investors, such as private equity houses. Key to this is ensuring that any bid vehicle – the future holding company – will be engaged in an economic activity and evidencing this at an early stage. Establishing a management services agreement between the holding company and subsidiaries is recommended, but care must be taken to ensure that the management charges are raised and paid on a regular basis or of otherwise evidencing there is a genuine intention to make taxable supplies.
If the uncertainty over VAT recovery has resulted in input VAT not being recovered, or not being recovered in full, over the last four years then now would be an ideal time to review whether there is an opportunity to recoup more of the VAT which was incurred. Those planning corporate finance transactions should take advice on their VAT position at an early stage.
For help and advice on VAT recovery on deal fees or on holding company costs more generally please get in touch with Marc Welby.
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