Full VAT recovery for private equity funds?

16 January 2020

In a recent decision in the case of Melford Capital, the First-Tier Tribunal has ruled that a VAT group consisting of a Private Equity (PE) fund and its Manager was entitled to full VAT recovery. Too good to be true? Probably.

While this makes for an interesting headline, for a number of reasons the floodgates for VAT refund claims are unlikely to open as a result of the decision. Firstly, the case involves a specific fact pattern which will not apply to all PE funds (see below). Secondly, the case does not set a binding precedent, as this only comes if the decision is made at the Upper Tribunal or higher and we would expect HMRC to appeal the decision. Notwithstanding the reasons for caution, the judgment does discuss some key VAT issues facing private equity and is certainly worth a closer look.


The taxpayer consisted of a VAT group including the Manager and General Partner (GP) of a real estate fund. By virtue of the GP, the fund was treated as a member of the VAT group.

The Manager provided management services to the GP. It also provided advisory services and charged fees to a number of special purpose vehicles (SPVs) under a tripartite arrangement with the GP. The SPVs were held by a holding company (Holdco) 100% owned by the fund, which was not part of the VAT group.

Any disposals would take place at either the SPV or Holdco level. This was a crucial point as it meant that the VAT group would never make an exempt supply.

The VAT group had sought full VAT recovery. This was contested by HMRC as it regarded the fund as having a non-business activity because in it would only ever receive dividends and did not make any taxable supplies in its own right.

Tribunal’s decision

The Tribunal rejected HMRC’s arguments and decided that the VAT group was entitled to full VAT recovery on fund related costs. It concluded that the GP provided advisory services to the SPVs.

This was on the basis that the GP and the Manager were members of the same VAT group and, as such, the Manager’s advisory services to the SPVs were deemed to be provided by the GP (who was the representative member of the VAT group). The Tribunal considered that the GP effectively acted as a holding company that was in business for VAT purposes and made no exempt supplies. It did not consider that the GP was undertaking a separate non-business investment activity. Therefore, the Tribunal decided that the costs for setting up and operating the fund had a direct and immediate link with the GP’s onward business of providing taxable advisory services to the SPVs. As such, the Tribunal decided that input VAT was fully recoverable.


The decision suggests that full VAT recovery may be available to PE funds which:

  • Have a controlling equity stake in investee companies,
  • Only make disposals at a level beneath the fund (outside of the VAT group), and
  • Are VAT grouped with a manager who provides taxable services to those investee companies.

However, there are a number of aspects the case did not consider, leaving open many questions for another day. For example, is there a difference between a real estate fund which may intend to hold investments for the long term and a PE model which aims to exit investments within five to seven years? For the latter, is it harder to argue that the fund is acting like a holding company when the primary aim is to profit on the sale of shares rather than to run a long-term trading business?

Another unanswered question is: Does the ratio between taxable management fees earned and the costs of investments matter? HMRC has often taken the view that if a VAT group is in a regular or permanent loss making position, it is indicative that it is not in business for VAT purposes and, therefore, the VAT group should suffer an input tax restriction.

The decision also goes against the grain of recent case law which has indicated that VAT grouping is a fiction which should not take away the reality that each VAT group member is a distinct person with its own activities.

HMRC considers that PE funds should have minimal VAT recovery as profiting from disposals will either be an exempt supply (direct exits) or passive non-business income (dividends from indirect exits), neither of which allow VAT recovery (with the exception of direct exits to a non-EU buyer).

While this decision puts a dent in HMRC’s policy, it is unlikely to change its stance and we would expect HMRC to appeal the case or seek to sideline it as having no wider application. However, unless and until that happens, we do have a First Tier Tribunal decision which PE funds should consider in light of their own fact patterns to determine if any action is warranted concerning their own VAT profile. It is certain that VAT and private equity will continue to be a complex and often contentious area and one where we increasingly see greater scrutiny from the tax man – it’s always a good idea to be ready for when he comes calling.

Please contact Stephen Kehoe or your usual VAT adviser if you would like to discuss how this case is relevant to your business.