Herbert Smith has successfully acted for BAA Limited (BAA) in a landmark case where the First Tier Tax Tribunal has held that VAT incurred on professional fees by a bidder in the context of a takeover offer is recoverable. The VAT was recovered on the basis that it was attributable to the general overheads of the target group.

This decision is significant and will be of material interest to taxpayers who incurred what they thought (or have been advised by HMRC) was irrecoverable input VAT in the context of takeovers or similar transactions. The BAA case is the first of its kind to be heard and decided, but a number of recent notable public takeovers give rise to the same questions, and appeals to the Tax Tribunal have been stood over pending the decision in the BAA case. HMRC's reaction to the decision is awaited.


BAA was acquired in Spring 2006 by a company set up for the purpose of making the acquisition (Bidco) by a consortium led by the Spanish infrastructure group Ferrovial. Following the takeover, Bidco joined the BAA VAT group and the group's representative member sought to recover the VAT incurred on fees paid by Bidco to its various professional advisors in connection with the takeover. HMRC refused the recovery and BAA appealed the decision.

Background Law

Recovery of VAT

As a general principle of VAT law a 'taxable person' (a concept used by the VAT legislation to describe a person who is engaged in economic activities) should be able to recover all the input VAT incurred in the course of such economic activities. Conversely, VAT is not recoverable by the 'end user', or the person who acquires supplies on which VAT has been charged, but who is unable to show that the supplies were used by it in connection with its economic activities.

It is established law that the mere holding of shares in a subsidiary does not amount to an economic activity for VAT purposes. Hence VAT incurred by a parent company, which is a mere holding company, in connection with the acquisition or disposal of the shares in subsidiaries, is generally not recoverable.

In contrast, a parent company which actively manages its subsidiaries in return for a fee will be carrying on an economic activity for VAT purposes and may therefore recover input VAT incurred on professional fees in connection with the acquisition or disposal of shares in its subsidiaries.

It is also established law that acts undertaken by a person in preparation for carrying out an economic activity will be considered to be part of that economic activity. Accordingly, a person is entitled to credit for input VAT incurred on services supplied to him for the purposes of preliminary work ultimately intended to be used in connection with an economic activity in the future, whether or not such activity ultimately takes place.

VAT groups

The UK and certain other EU jurisdictions allow companies which form part of the same group, broadly as defined for Companies Act purposes, to elect to be grouped for VAT purposes. A VAT group is treated as a single person for VAT purposes, so supplies between group members are ignored and the 'representative member of the group is treated as carrying on the business of all members of the group.

HMRC Arguments

In denying the recovery of VAT incurred on supplies made to Bidco, HMRC argued that at the time such supplies were made to Bidco it did not carry on an economic activity. Instead Bidco acted as an investor whose sole purpose was to acquire the shares in BAA. VAT incurred by Bidco could not therefore be recovered. Put differently, Bidco never demonstrated an intention to make taxable supplies and did not in fact do so, and as a result VAT recovery should be denied. Bidco's intention to join the BAA VAT group after the takeover does not affect the analysis and was not sufficient to establish that Bidco intended to make taxable supplies at the time that it incurred the input VAT in question.


The Tribunal concluded that the VAT incurred by Bidco was recoverable by the representative member of the BAA VAT group. This was on the basis that Bidco did carry on an economic activity from the moment it was incorporated, and despite the fact that it never made taxable supplies itself. The Tribunal found that Bidco's activities went beyond the mere acquisition and holding of shares: by way of example the Tribunal held on the evidence before it that the fees incurred were attributable to Bidco's negotiation and arrangement of finance for the benefit of the operations of the BAA group (as well as for the acquisition of the group). Despite not making taxable supplies in its own name and having no intention to do so, the Tribunal considered that the decision of the ECJ in Faxworld1 allows consideration of the intention to make taxable supplies by reference not just to the person incurring the VAT (here Bidco) but also, in this case, another person (the BAA VAT group) with whom Bidco became grouped for VAT. In these circumstances there was a direct and immediate link between the input VAT incurred by Bidco and the output VAT charged by the representative member of the BAA VAT group (which included Bidco).

The Tribunal consequently held that the input VAT was recoverable as part of the general overheads of the representative member of the group. In reaching this conclusion, the Tribunal extended the principle set out in Faxworld (that a person may recover input VAT by reference to the output VAT charged by another person) to the facts of this case, on the basis that the 'fundamental principle of fiscal neutrality' required it.


The case is significant for a number of reasons:

  1. The recoverability of VAT incurred in respect of takeover bids has been in question for a while, and the case provides some guidance on the point which may be of much wider application.
  2. The case confirms that companies contemplating a takeover should be able to recover VAT incurred on fees if they can show an intention to make taxable supplies. The discussion contained in the decision suggests that this may be achieved by the bidding company showing an intention to supply taxable services to target post takeover (e.g.: management services), but following the decision, the intention to make taxable supplies may also be established where the acquirer is grouped for VAT purposes with target as soon as the takeover completes.
  3. Importantly, the decision relies on the factual set up relevant to the takeover of BAA, and in particular the integral nature of the services provided to Bidco pre as well as post takeover. It would appear that had the services related solely or primarily to the acquisition of BAA, as opposed to involvement in post-acquisition funding and management, VAT recovery may not have been allowed.

The future

The decision may be appealed by HMRC, given the significance of the issue and the amount of tax revenue which some publications have been suggesting is at stake.

In the meantime, companies which have previously been unable to recover input VAT in this or similar circumstances should seek advice as to how to proceed and what to do to protect any possible claim.