Summary and implications

In the Court of Appeal:

  • BAA Ltd has lost its battle to recover £6.7m of input tax incurred by a special purchase vehicle (SPV), during the course of its takeover of BAA Plc;
  • the SPV was found not to be engaged in “economic activity” for the purposes of VAT, at the time that it incurred the liability to pay VAT on professional services; and
  • it was emphasised that automatic VAT recovery for an SPV holding company should not be assumed as the acquisition and holding of shares is not sufficient to constitute economic activity for the purposes of VAT. The SPV will need to demonstrate that it is engaged in economic activity, and therefore making taxable supplies, in its own right.


Airport Development and Investments Limited (ADIL) was established to facilitate the takeover of BAA plc (BAA) by the Spanish group Ferrovial. The purpose of ADIL was to acquire the entire share capital of BAA with a view to managing and operating the group business of BAA, namely the running of UK and international airports, on an ongoing basis.

ADIL was incorporated in March 2006. During the course of the takeover, ADIL sought and obtained both legal and financial advice, thus incurring input tax, at a time when ADIL was not registered for VAT. The takeover completed in June 2006 and ADIL subsequently joined the BAA VAT group. As the representative VAT member of the BAA VAT group, BAA Ltd sought to recover the input tax on professional fees incurred by ADIL prior to completion of the takeover. This was on the basis that the input tax incurred should be offset against the output tax on the taxable supplies made by the BAA VAT group. HMRC refused recovery.

Legal framework

The legal basis for VAT recovery is well established and there is little scope for interpretation of the concepts; however the case turned on the application of the law to the facts.

The court held that in order to recover VAT, ADIL needed to establish that:

  • it was carrying on an “economic activity” when it incurred liability to pay VAT; and
  • there was a “direct and immediate” link between the input tax incurred by ADIL on the professional fees and, since ADIL did not make any taxable supplies itself, the taxable supplies made by the BAA VAT group, whether in relation to specific outward tax supplies or to the BAA Group’s economic activity as a whole.

It is settled law that for VAT purposes, the acquisition and holding of shares does not constitute “economic activity” unless the acquisition is accompanied by the provision of management services by the parent to the subsidiary.

The case for BAA Ltd

BAA Ltd argued that VAT was recoverable as:

  • at the time of incurring the liability to pay VAT, ADIL was engaged in the economic activity of preparing for the acquisition of BAA; and
  • there was a direct and immediate link between the taxable supplies made to ADIL in connection with the takeover, and the taxable supplies made by BAA during the course of its post-completion business. BAA Ltd argued that the acquisition was the “first necessary step” in ADIL’s larger involvement and long- term investment in UK airport infrastructure, and that therefore ADIL ought to be able to recover the input tax incurred as a general overhead of the BAA VAT group.

Case history

The First-tier Tribunal had agreed with BAA Ltd’s contentions at first instance and held that VAT was recoverable. However on appeal although it was accepted that ADIL was engaged in economic activity, the Upper Tribunal found that there was no direct and immediate link between the taxable supplies made to ADIL during the course of the takeover and the taxable output supplies of BAA or the group as a whole, so input tax could not be recovered.

Court of Appeal

In a unanimous decision, the Court of Appeal drew a different conclusion to both the First-tier and Upper Tribunals. Crucially it held that ADIL was not engaged in economic activity at the relevant date. The Court of Appeal placed weight on the factual findings of the First-tier Tribunal, that prior to the point at which ADIL incurred VAT, ADIL had neither made, nor had any intention of making, any taxable supplies, or formed the intention to join the BAA VAT group. It had simply acquired the shares in BAA and had not carried on an economic activity in its own right.

On this point alone, BAA’s appeal failed, as any direct and immediate link was irrelevant if there was no economic activity being carried on. However, the Court of Appeal commented that the supplies of services to ADIL were only in connection with the takeover of BAA and were unconnected with any supply ADIL intended to make. In fact ADIL never made any taxable supplies in its own right following completion of the takeover.

In addition, BAA’s onward supplies were not connected with the supplies to ADIL on which input tax was incurred, nor was there a link to the general overheads or any continuing benefit after the takeover, direct and immediate.

Impact – crash and burn

BAA’s plight serves as a warning to prospective buyers where a purchase is to be structured through a SPV. Think about VAT upfront as if the SPV fails to demonstrate the requisite evidence of economic activity, together with a direct and immediate link between the costs incurred and onward taxable supplies probably of management services, this is likely to result in an unexpected tax cost.

It seems that BAA had not learnt the lessons from the 1991 case of Polysar. Following that case HMRC released guidance (see HMRC Manual: VIT40100) setting out what a holding company needs to do in order to recover input tax.

It remains to be seen whether leave will be granted for this case to be appealed to the Supreme Court. Given that it was a unanimous decision by the Court of Appeal, and it was emphasised that the case turned on the application of settled law to the facts, it is perhaps doubtful.