On 20 April 2017, HMRC updated their guidance on the often contentious issue of input VAT recovery by holding companies. This follows the CJEU decision in the joint cases of Larentia + Minerva and Marenave Schiffart (C-108/14 and C-109/14).
Previously, HMRC were of the view that where a holding company incurred VAT on the costs of acquiring a new subsidiary, such VAT was only recoverable where it was directly attributable to the onward provision of taxable management or technical services to such subsidiaries. Such input VAT also had to be apportioned between any non-economic activity (i.e. holding shares as an investment) and economic activity (i.e. the provision of management services) of the holding company.
The economic activity requirement
In HMRC’s revised guidance, it has been confirmed that in order to recover VAT on such costs, the holding company:
- must be the recipient of the supply; and
- must be undertaking economic activity for VAT purposes (which involves the making of onward taxable supplies).
This ostensibly appears to relax the requirements for VAT recovery in HMRC’s previous guidance (as above), but the revised guidance goes on to stress that there must still be a direct and immediate link between the costs incurred and taxable supplies made by the holding company in the course of its economic activity. This is unsurprising, as it is an established principle in VAT jurisprudence – helpfully, the revised guidance goes on to confirm that if the holding company provides taxable management services to all of its subsidiaries, any VAT incurred on acquisition costs will be recoverable. It follows, however, that where a holding company carries out both economic and non-economic activities (for example, if it makes taxable supplies to only some of the subsidiaries acquired) input VAT recovery is only allowable to the extent that it relates to the economic activity of providing services to the subsidiaries. The VAT incurred would therefore need to be apportioned between the economic and non-economic activities.
It follows that a holding company intending to provide management services to the acquired group should ensure that it provides such services to all companies within the group. Furthermore, this is not of itself sufficient to ensure VAT recovery, as is explored below.
The requirement for consideration
HMRC’s revised guidance also explores the concept of whether and to what extent an economic activity requires supplies to be made for a consideration.
Previously HMRC expressed the view that VAT on costs incurred by a holding company was only recoverable if there was an intention to recoup such expenditure from the income derived from onward taxable services provided by the holding company to its subsidiaries within a reasonable time – i.e. if the consideration actually paid for the services supplied by the holding company was of a sufficient amount. HMRC’s view of a “reasonable time” was five to ten years. This requirement has also now been dropped from HMRC’s guidance.
This latter change is welcome, but does not remove the need for holding companies to focus on the requirement for proper consideration. Recent case law on the “substance” of onward taxable supplies by holding companies shows that it remains important for holding companies not only to document and evidence an intention to make onward taxable supplies but for those supplies to actually be made for a consideration. Importantly, such consideration must arguably be more than a nominal fixed fee and not be calculated, for instance, on the ability of the subsidiary to pay such fees. Therefore, in reviewing fees in the relevant management services agreement, a cautious approach may be to continue to determine the consideration to some extent by reference to the amount of the costs incurred by the holding company on which the relevant VAT was charged. In any event, fees should be definitively set and actually charged (and not, for example, allowed to be contingent on a subsidiary’s ability to pay).
HMRC also confirmed that input VAT recovery is possible where a subsidiary is acquired “as a direct, continuous and necessary extension of a taxable economic activity of the holding company”. In such cases, the VAT incurred would have a direct and immediate link to taxable supplies and be recoverable. Examples provided by HMRC include an existing business acquiring a direct competitor with a view to increasing market share (which would be contrasted with a company acquiring another company as a free-standing enterprise with a view to deriving a return from that enterprise).
This is of less relevance in private equity structures where specific acquisition vehicles are usually incorporated for the purpose of acquiring a target. Such a holding company formed specifically for this purpose (e.g. a buy-out) would not fall within HMRC’s examples and would, as a result, need to adhere to the principles set out above (i.e. the provision of onwards taxable supplies to the target post-completion in the form of management services).
HMRC have provided additional guidance in respect of holding companies and VAT grouping. Sadly, this guidance is not entirely clear. HMRC note that merely joining a VAT group does not give rise to an entitlement to recover VAT (i.e. VAT grouping will not change a non-economic activity into an economic activity for VAT purposes). Therefore, if the holding company is merely holding shares in newly acquired subsidiaries as an investment, then related input VAT should be irrecoverable. The guidance becomes more problematic where it notes that where a holding company provides management services or interest bearing loans to companies acquired in its VAT group, related input VAT is recoverable to the extent that the costs support taxable supplies made and the management services/loans “can be seen to support the making of taxable supplies by the VAT group”. This analysis is arguably inconsistent with the position in VAT groups where all supplies are treated as made to and by the representative member (and supplies within the group are disregarded for VAT purposes). The best approach would seem to be to continue to adopt the above approach of ensuring the holding company intends to and actually makes onward supplies of services to all group members.
Analysis and practical advice
The updated guidance provides some welcome relaxation in the difficult areas of linking costs to economic activity and the need for consideration to support an economic activity, but remaining grey areas may ultimately mean there is little change to current commercial practices in respect of holding company VAT recovery.
Overall, to maximise the ability of a holding company to recover VAT on acquisition costs, the holding company should:
- consider applying for VAT registration as soon as possible;
- provide onward taxable supplies to the Target upon acquisition (i.e. management services), including to any other subsidiaries already held within its group;
- evidence its intention to provide such onward taxable supplies (i.e. during the initial board meeting);
- charge consideration in respect of its onward supply of management services which is fixed, actually charged and of sufficient substance (bearing in mind recent case law); and
- be party to all relevant engagement letters relating to the acquisition from the beginning, receive the relevant invoices relating to acquisition costs and pay such invoices from its own funds (such invoices should only be raised to the holding company once it has registered for VAT).
It should also be considered whether the holding company should form a VAT group with the Target. However, this is arguably of less importance than the key practical measures to facilitate input VAT recovery on acquisition costs, which are set out above.
Given the complexities of input VAT recovery on acquisition costs, this issue should be considered as early as possible in every acquisition process (in order to avoid such input VAT becoming an additional absolute cost relating to the acquisition).