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