For several years the question of whether and to what extent VAT incurred on transaction costs related to share acquisitions should be recoverable has been a hot topic for tax advisers and tax authorities alike throughout Europe.
A series of domestic court decisions in the past couple of years have failed to shed clear light on the steps required for a holding company to recover VAT on such costs, and the waters became murkier still when HM Revenue & Customs updated its VAT Input Tax Manual in September 2014 to provide more details on when it considers VAT recovery may be possible. Amongst those details was a suggestion that where a holding company provides management services to subsidiaries within a group, it would be necessary for the company actually to recoup the costs in question through fees for those services and within a reasonable period (see VAT – policy on holding companies).This suggestion appeared to have no express support in case law.
The recent judgment of the Court of Justice of the European Union (CJEU) in the joined German cases of Larentia & Minerva mbH & Co KG and Marenave Schiffarts AG has provided some clarity on where the boundaries lie for holding companies seeking to recover VAT, but may have introduced complications for holding companies that are unable to demonstrate active management of all of their subsidiaries. This note summarises the position following this judgment and possible further developments.
By way of brief background for those fortunate enough not to be familiar with the convoluted details of this area of the law, where a company incurs VAT on costs it can, as a general rule, recover that VAT if the costs in question can be shown to be incurred in the course of an economic activity and to have a direct and immediate link to taxable supplies that the company carries on (or will carry on). As the costs incurred on M&A transactions can be substantial, this places a significant importance on the issue of recovering VAT on those costs.
The difficulty in M&A transactions, and particularly M&A undertaken by private equity funds, is in establishing a link between the transaction costs and the ongoing activity of the acquiring company (“Bidco”). Long-standing authority of the Court of Justice of the European Union (CJEU) states that acting as a holding company, without any further commercial or management activity, is not sufficient to be regarded as an economic activity that would justify the company registering for VAT and hence recovering VAT on its costs (Polysar Investments Netherlands BV v. Inspecteur der Invoerrechten en Accijnzen).
Subsequent cases have determined, however, that:
- Management of subsidiary companies can constitute an economic activity, if accompanied by activities such as the provision of administrative, financial, commercial or technical services.
- Merely agreeing to provide such services may not constitute an economic activity if terms are not agreed for a price or consideration for such services.
- Even if a price is agreed for services, failure in fact to pay that price (even if it is left outstanding as a debt) may be treated as evidence that there is no consideration and, hence, no economic activity.
- Where costs are incurred prior to an acquisition (as was the case in the BAA plc litigation that has become central to the debate in this area) it is necessary for the company in question to demonstrate a clear intention to carry on economic activities for it to be able to recover VAT on costs.
In response to the uncertainty, the tendency of advisers has been to recommend a twin-pronged approach for new holding companies, comprising the entering into of a management services agreement (MSA) on completion of the relevant buy-out, for the holding company to provide services to members of the target group, and for the holding company also to join aVAT group with members of the target group (the latter measure designed to support an argument that costs of the holding company could be attributed to taxable business to be carried on by the VAT group as a whole).
Recent HMRC Practice
Perhaps in light of two decisions of the First-Tier Tribunal holding against the taxpayer, HMRCissued revised guidance in Autumn 2014 including examples of circumstances where a holding company might be accepted as having an economic activity that would justify VATrecovery. Amongst other statements, HMRC noted their views that:
- VAT on costs incurred by a holding company may be recoverable if the intention is to recoup the expenditure from the income resulting from taxable services provided to subsidiaries. In many cases the intention will be that such costs are to be recovered over a period of time. When setting prices to recoup the cost of capital expenditure HMRCexpects businesses to take into account the need to make an adequate return on the capital expenditure and the future costs that they are likely to incur in relation to the assets acquired. Therefore HMRC are likely to challenge claims that the costs are to be recovered over timescales which would not allow the capital expenditure to be recouped for many years. [HMRC go on to note that a “sensible period” to recoup costs might be between five and ten years].
- It is important to remember that joining a VAT group does not, of itself give rise to an entitlement to recover VAT. It cannot change a non-economic (i.e. out of the scope) activity into an economic activity. Nor does it create a direct and immediate link between an input cost and a taxable output unless one can be traced through the intra group supplies.
There appears to be no express support in case law for the contention that only where costs will be recouped over a specific period of time should they properly be regarded as component parts of onward taxable supplies. Similarly, the inference that a holding company that intends to (and in due course does) join a VAT group with trading companies in the target group will not as a result of this alone be able to recover VAT on the costs of acquisition is unconfirmed in case law.
Notwithstanding this, HMRC’s practice has led to considerable uncertainty as to the correct approach to take regarding acquisition costs incurred in the past year, and in relation to the treatment of acquisitions completed prior to the above guidance being included within the manual.
Larentia & Minerva – the latest position
The recent CJEU cases of Larentia & Minerva and Marenave Schiffarts concerned shipping companies that incurred costs in raising capital to acquire interests in various target vehicles. In each case, the companies in question were able to demonstrate an intention to provide management services to the acquired entities.
The court held that costs connected with the acquisition of interests in target vehicles by a pure holding company that carried on an economic activity (i.e. providing services to the target entities) was to be considered attributable to that activity. Hence VAT on the costs would be recoverable in full. The court noted that active involvement in the management of a subsidiary by a holding company, involving the provision of administrative, financial, commercial or technical services, would constitute an economic activity – it is notable that no reference was made to the level of or even the need for remuneration for such services.
However, the court also noted that a holding company could carry on both economic and non-economic activities, where it both provided “active” management to some subsidiaries, but did no more than hold shares in others. The court left it to national authorities to set down suitable criteria for apportionment of VAT between economic and non-economic activity in such circumstances.
Although a positive decision in the sense of confirming the potential to recover VAT on deal costs by attribution to management service arrangements, the latest CJEU judgment in this area still leaves some areas of uncertainty. It is unclear, for example, whether a holding company that acquires a single target company that itself has multiple subsidiaries need demonstrate active management of merely the target company, or also the other group companies. As the distinction drawn is between the economic activity of providing management services and the non-economic activity of acquiring and owning shares, it is tempting to conclude that provided services are demonstrably provided to the target company that will be sufficient (because the holding company does not as a strict matter acquire and hold shares in any other company). However the position is unclear and it would be prudent to ensure that suitable management service agreements are in place to provide for the provision of administrative and management services by the holding company to all group companies.
Furthermore, although the judgment appears to confirm that the provision of such services is in itself sufficient to amount to an economic activity, it is not expressly stated that the existence or quantum of consideration for such services is not relevant. As such, it must be considered prudent to continue with the provision of a suitable and, where possible, arm’s length fee arrangement for services and for those fees actually to be paid.
Notwithstanding the above, that the judgment is silent on many of the factors apparently considered essential by HMRC to VAT recovery has served to increase pressure on HMRC to revisit their most recent published practice. Indeed, HMRC have accepted that this guidance was subject to the outcome of this litigation, so further announcements must be expected soon.