The recovery of VAT on deal fees in private equity backed transactions has long been the subject of HMRC challenge - and ever changing guidance. Following a series of meetings with HMRC during 2015 and 2016, involving BDO and other leading advisers, many of the historic cases which were being litigated have now been resolved. As part of this process, and with the benefit of the judgement of the Court of Justice of the European Union in Larentia + Minerva and others, a number of principles were established. These include the factors which point to the Bidco as the recipient of the services to which the fees relate and the activities which Bidco must undertake to secure VAT recovery. Having previously suggested a Revenue & Customs Brief would be issued, HMRC has now issued guidance – albeit in draft for consultation – which sets out its (draft) revised policy.
What does the new draft guidance say?
HMRC consider that a Bidco is the recipient of a supply where all of the following conditions are fulfilled:
- The Bidco has contracted for the supply, including by novation
- It has made use of the supply
- The supply has been invoiced to it; and
- The Bidco has paid for the supply.
Once Bidco has been established as the recipient of the supplies, it must be engaged in “economic activities” to be entitled to recover the associated VAT. In simple terms, it must make or intend to make supplies of management services to its subsidiaries to which the costs in question can be attributed. Furthermore, the draft guidance makes clear that there must be “consideration” for such management services and that they need to be “genuine and more than nominal”. When these tests are met, the deal fees should be regarded as an overhead of the business as a whole and the VAT should be fully recoverable (subject to any partial exemption restriction).
According to HMRC, putting Bidco into a VAT group does not, of itself, give an entitlement to VAT recovery and so Bidco must be “economically active” in its own right, for example, by providing management services or loans to the companies acquired in the VAT group. Where intra VAT group charges are made, Bidco’s VAT will be recoverable if there is either a link which can be traced through the intra group supplies to the taxable outputs of the group, or the costs are such that they are “properly and naturally attributable to the VAT group’s taxable outputs”. Similarly, VAT on costs which have a direct and immediate link to taxable supplies made by Bidco to a company outside the VAT group will be recoverable. If, however, Bidco makes management charges to some, but not all, of its subsidiaries, it will be deemed to have non-economic activities and will not be entitled to recover the VAT attributable to the management of the subsidiaries it doesn’t charge.
HMRC has also confirmed that certain on-going costs which may be invoiced to the Bidco can be treated as a cost of the VAT group 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 confirm that VAT on vendor due diligence costs may also 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.
What this means
It must be remembered that the guidance is only draft and so it may be subject to change. So saying, it gives a good indication of the direction of travel and, in our view, it is unlikely that any changes will result in a further tightening of the VAT recovery rules on deal costs.
HMRC has abandoned the requirement for Bidco to recoup deal fees over a ‘reasonable timescale’, or to demonstrate a specific link between the VAT on the deal fees and the VAT charged on the supplies by Bidco to the target group (or by the VAT group to its customers). This is to be welcomed, as is the confirmation of how Bidco can satisfy HMRC that it is the recipient of supplies.
Evidencing the intention of the Bidco to make taxable supplies (or to make supplies within a VAT group) is critical. An appropriate management services agreement between the Bidco and its subsidiaries is one way of helping to achieve this. However, it won’t be enough on its own – Bidco will need to ensure that management charges are both raised and paid, and on a regular basis.
If investee companies incurred costs on vendor due diligence and did not recover the VAT on those costs, there may now be an opportunity to revisit that decision, at least for costs incurred within the last four years.
If you currently have a live deal for which input is needed or you would like to discuss these developments in more detail, please call Marc Welby, who led BDO’s discussions with HMRC. Marc can be reached at 020 7893 3580 or firstname.lastname@example.org