Airtours is Denied a Deduction for VAT Paid on Fees Charged by  Advisors on its Restructuring

SUMMARY

Airtours Holidays Transport Limited has been denied recovery of VAT on fees it paid to  PricewaterhouseCoopers LLP for a review of Airtours’ financial position in connection with its possible  restructuring.

The Court of Appeal found that PwC was under no contractual obligation to provide services to  Airtours, even though Airtours was a party to the engagement letter, was entitled to receive a copy of  PwC’s report, and was responsible for paying PwC’s fees.

The case is significant for UK-based companies seeking to recover input VAT in respect of fees and  other overheads. It shows that a taxpayer will not be able to recover input VAT unless the contractual  documentation makes clear that the relevant VATable supply is made to it. It is not enough that the  supply may involve some level of “benefit” to the taxpayer; and/or that the taxpayer is responsible for  paying for the supply.

THE CASE

A. BACKGROUND

PwC was hired in November 2002 to facilitate a refinancing and restructuring process for Airtours,  which was in severe financial difficulties. Airtours was responsible for paying PwC’s fees, but the  situation differed from a typical obligation on a borrower to pay the fees of its bank’s professional  advisors (acting for the bank alone) for several reasons. First, both the restructuring banks and  Airtours were party to the engagement letter with PwC. Second, Airtours had a say in deciding to  instruct PwC rather than a competitor firm. Third, Airtours was entitled to receive a copy of PwC’s report to the banks, and it was accepted by the Court of Appeal that PwC probably owed Airtours  some level of legal duty of care.

B.THE POINTS IN DISPUTE

For VAT to be recoverable in this instance, Airtours had to be able to identify:

  • the payment made for the service; and
  • a supply obtained by it for the purposes of its VATable business.

It was not in dispute that PwC supplied services to the banks. Since Airtours clearly made payment to  PwC for its services, the central question was whether there was a supply of services by PwC to  Airtours (as well as to the banks).

C. THE TRIBUNAL DECISIONS

The First-tier Tribunal found that Airtours had received a supply of services from PwC for the  purposes of its business, and therefore could recover VAT on the fees charged to it by PwC. It  highlighted that Airtours had:

  • played a role in the selection of PwC;
  • agreed and authorised the scope of PwC’s work;
  • received a copy of the PwC report (and was not bound to send the report to the banks);  and
  • needed the review for the purposes of its VATable business (since the PwC analysis was  critical to the banks continuing to provide funding to Airtours).

HMRC appealed to the Upper Tribunal, which allowed the appeal and held that PwC’s services were  supplied to the banks only. Services were not supplied to Airtours, even if it did obtain some collateral  benefit as a result of the supply of services. The purpose behind Airtours being party to the  engagement letter was simply to oblige Airtours to meet the cost of PwC’s services.  Airtours then appealed to the Court of Appeal.

D. THE COURT OF APPEAL DECISION

The Court of Appeal released its decision on 24 July 2014 1 . It decided (by a 2:1 majority) that the  services were indeed supplied solely to the banks and not to Airtours, although there was a strong  dissenting judgment.

The most important elements, to be ascertained by reference to the “economic realities” of the  transaction, including the legal documentation, were the nature of the transaction and what (if  anything) Airtours received in exchange for the consideration it paid to PwC.

An objective test is required to determine whether a VATable supply has been made. It was not  enough that Airtours received some “benefit” from the services, nor that it needed PwC’s report in  order to continue its business.

The majority in the Court of Appeal held that the First-tier Tribunal had failed to apply an objective  test, since it had given weight to Airtours’ intentions and its subjective needs (i.e., to secure continued  funding from the banks). In the opinion of the majority, these factors should not have overridden the  contractual terms of PwC’s engagement, which were to provide services solely to the banks. The  Upper Tribunal had correctly answered the objective question by analysing the engagement letter and  determining that the “economic reality” of the situation was that Airtours did not receive services from  PwC for the purposes of its business. If Airtours received any benefit from the arrangements, this  derived from the banks’ continued funding, and not from any services supplied to it by PwC.

IMPLICATIONS

Despite some encouraging wins for taxpayers in the field of input VAT recovery, such as Redrow 2 and  Aimia 3 , the case indicates that there are limits to the idea set out in Redrow that it may suffice for the  taxpayer to be able to recover input VAT if it has received any benefit at all for the purposes of its  VATable business from the supply of VATable services. Indeed, although the Supreme Court ruled  (by a bare majority) in the taxpayer’s favour in Aimia, it was at pains to limit the scope of Redrow.

Like last year’s decision in  BAA 4 , the decision also highlights the importance of carefully-drafted  engagement letters governing the terms under which services are supplied, and the person(s) to  whom they are being supplied. Had Airtours not been party to the engagement letter with PwC, its  claim for VAT recovery would almost certainly not have reached the courts. However, as the case  shows, simply being party to a contract under which a supply is to be made is not sufficient grounds  for recovering VAT unless it is clear that the contract requires the supply to be made to that party.

The division of opinion in the Court of Appeal, and the divergent approaches of the First-tier Tribunal  and Upper Tribunal, demonstrate that input VAT recovery cases are very much questions of  contractual interpretation, even if the wider economic realities must also be taken into account. Similar  principles will apply to determine whether services are supplied to a non-UK-based person. This is  particularly important because services supplied to a non-UK-based business are typically “outside  the scope” of UK VAT, and therefore the supplier should not charge UK VAT on those services. Such  decisions can be finely balanced, even in cases where there is a detailed engagement letter. HMRC has yet to issue any updated guidance following its successes in BAA and Airtours, but it is  widely anticipated that HMRC will be stepping up its challenges to businesses seeking to recover input VAT on transaction costs.  This is of particular relevance to private equity and restructuring  transactions. Parties should consider the VAT position on transaction costs as soon as possible in the  deal process in order to maximise their chances of VAT recovery.

It will be interesting to see whether Airtours seeks leave to appeal to the Supreme Court and, if so,  whether the Supreme Court declines to hear such an appeal on the ground that the decision is heavily  fact-specific.