BAA has been defeated in the English Court of Appeal in its attempt to recover £6.7m of value added tax incurred on deal costs during a successful takeover bid. The case is significant for UK-based financial buyers: it shows how important it is to plan for VAT recovery early and to make sure there is evidence of the bidding company’s intentions.
More significantly – and more welcome to taxpayers – the European Court of Justice has decided that member states may allow non-taxable persons (such as pure holding companies) to be members of VAT groups.
THE BAA CASE
The British Airports Authority was privatised as BAA plc in 1987. By 2006 BAA owned seven airports in the UK, including Heathrow and Gatwick, and had stakes or management roles in a number of airports outside the UK. It was listed on the London Stock Exchange and included in the FTSE 100 index. The Spanish infrastructure group Ferrovial, which already had stakes in two UK airports, formed a consortium with two other investors in order to make a takeover bid for BAA. In March 2006 the consortium incorporated a UK holding and management company, ADIL, to pursue the bid and – if the takeover succeeded – arrange finance and provide governance for the group.
ADIL made its first formal offer in April 2006. BAA took the view that ADIL’s bid undervalued the company and rejected it. A consortium led by Goldman Sachs made a competing approach to BAA and a bidding war ensued. BAA eventually agreed to recommend ADIL’s offer and it was accepted by shareholders in June 2006.
ADIL paid considerable fees to its advisors for work done on the takeover: £30 million plus VAT to Macquarie, its financial advisers, and approaching £10 million plus VAT to its other advisers. The VAT totalled nearly £6.7 million.1
After the takeover ADIL and the BAA group began negotiations with lenders to refinance the group’s debt.
The group decided that ADIL should apply to join the BAA VAT group following the takeover. (Two or more eligible UK companies can apply to Her Majesty’s Revenue & Customs, the UK tax authority, to be registered as a VAT group. The group is then treated as a single entity for most VAT purposes.) The application was made in September 2006 and was – after an initial refusal – granted by HMRC with effect from September.
BAA then tried to deduct the £6.7m VAT incurred by ADIL (as “input tax”) from the VAT chargeable on BAA’s supplies (“output tax”). HMRC disputed this and assessed BAA to that amount. BAA appealed.
B. THE POINTS IN DISPUTE
To get a deduction for the VAT incurred on the deal fees, BAA needed to show two things:
- ADIL was carrying on (or intended to carry on) an “economic activity”; and
- the deal costs could be attributed, by a “direct and immediate link”, to outbound taxable supplies.
If ADIL was not carrying on (and did not intend to carry on) an economic activity, it was not itself liable to pay VAT (as a “taxable person”) and was instead in the position of a final consumer of services. Final consumers are meant to bear the burden of VAT, so cannot recover input tax. Even if ADIL were a taxable person as a general matter, if it could not show a link between its deal costs and outbound taxable supplies, it was in the position of a final consumer in relation to the deal costs.
1. “Economic Activity”
“Economic activity” has its own specific meaning for VAT purposes. In a line of cases going back more than twenty years, the European Court of Justice has decided that the mere ownership of shares and receipt of dividends (for example, by a holding company) is not “economic activity”: something more is needed, such as the provision to the subsidiaries of administrative or other services for consideration.
BAA argued that ADIL intended to carry out the active management of the BAA group following the takeover.
2. “Direct and immediate link”
For input tax to be recoverable, the inbound supplies must be attributable to outbound taxable supplies (that is, supplies subject to VAT). The term “direct and immediate link” is somewhat misleading: it is possible for inputs to have a “direct and immediate link” with the taxable supplies made through a business as a whole. What is important is that there is not a closer link with exempt supplies, or non-business activities.
Here, BAA appears to have advanced two lines of argument:
- The advisory services made to ADIL were linked to services supplied by ADIL to the rest of the BAA group.
- In the alternative, the services could be linked to the supplies made by BAA through the VAT grouping mechanism.
C. THE TRIBUNAL DECISIONS
The First-tier Tribunal found for BAA on both points.
HMRC took the case to the Upper Tribunal, which denied recovery: although – it said – ADIL was carrying on an economic activity, there was not a sufficient link between the taxable supplies made to ADIL and any taxable supplies to be made by ADIL or BAA.
BAA appealed to the Court of Appeal.
D. THE COURT OF APPEAL DECISION
The Court of Appeal released its decision on 21 February 2013.2 It decided against BAA on both grounds, and rejected its claim for input tax recovery.
1. ADIL Carried On No Economic Activity
BAA argued that ADIL had been set up with the purpose of providing strategic management services to BAA, and that it had followed through with this intention by actively managing BAA after the acquisition. BAA contended that this was sufficient to show economic activity on the part of ADIL.
The Court of Appeal, however, disagreed. Lord Justice Mummery said that ADIL had to show, at the date when the VAT was incurred, an intention to make taxable supplies to BAA of its management services. (The courts appear to have taken the date when the takeover was completed as being the key date here.) On the evidence provided, ADIL failed to show this. The Court of Appeal accepted that ADIL was created for the purpose of managing BAA after the takeover. But there was nothing to show that ADIL planned to charge BAA for its management services at the time when the advisory services were supplied to ADIL. (Indeed, it seems that ADIL never did charge the rest of the BAA group for its services.) If it was not going to charge for those services, they would not be taxable supplies.
BAA also argued that ADIL intended, by the time of the takeover, to join the BAA VAT group. ADIL would then be carrying on an economic activity as part of the group. On the facts, the Court of Appeal (relying on the findings of the First-tier Tribunal) found no evidence of any such intention. The judgment is unclear on whether or not an intention to join a VAT group carrying on economic activity, without any additional intention of making taxable supplies in its own right, would have been enough to show that ADIL intended to carry on an economic activity.
2. There Was No “Direct and Immediate Link” Between the Supplies Received and Made
As noted above, BAA appears to have advanced two lines of argument, similar to those it made on the “economic activity” point, linking the inbound supplies to:
- the services to be supplied by ADIL to the rest of the BAA group; or
- the supplies made by the BAA group, as a result of VAT grouping.
Both of these arguments were rejected by the Court of Appeal. Again, there was no evidence from before the takeover that ADIL intended either to make taxable supplies in its own right or to join the BAA VAT group. As with the economic activity question, it is not clear whether an intention to VAT-group on its own would have been sufficient.
The UK VAT rules on grouping allow a non-taxable person to join a VAT group. The European Commission, however, argued that the UK’s rules – and the similar rules in the Czech Republic, Denmark, Finland, Ireland, the Netherlands and Sweden – were contrary to the Principal VAT Directive, and that only taxable persons were eligible to join VAT groups. The Commission took infringement actions against the member states concerned to the European Court of Justice: the action against Ireland was chosen as the lead case.3
On 27 November last year Advocate General Jääskinen delivered an opinion in support of allowing non-taxable persons to join VAT groups. On 9 April the Court delivered its judgment, taking the same view.
Under the Principal VAT Directive, “each Member State may regard as a single taxable person any persons established in the territory of that Member State who, while legally independent, are closely bound to one another by financial, economic and organisational links.”4
The Advocate General and the Court had no difficulty in concluding that, read literally, the Directive allowed member states to include non-taxable persons in VAT groups. Furthermore, they rejected the Commission’s argument that the context of the grouping provisions and objectives of the Directive as a whole required groups to consist only of taxable persons. The member states concerned will therefore be able to leave their VAT grouping legislation as it stands.
As the BAA case suggests, UK-based bidders have used two main routes to claim recovery of VAT on deal fees:
- the provision of management services to their new subsidiaries; and
- VAT grouping.
The past few years have seen a move towards the management services route, partly as a result of the European Commission challenge to the grouping rules. But, even now that the Commission has failed to convince the Court of Justice that non-taxable persons should not be allowed to join VAT groups, the Court of Appeal’s decision leaves it unclear whether the grouping route works as a means of VAT recovery. It is of course possible that the BAA decision will be appealed to the UK’s Supreme Court and a Supreme Court judgment could bring more clarity; but taxpayers would be unwise to expect the Court of Appeal’s decision to be overturned. UK bidders who want to be certain they will recover their input tax on deal fees will need to go down the management services route.
The real lesson of the BAA case, though, is that VAT recovery cannot be an afterthought. Bidders should:
- intend, if their bid is successful, to make taxable (not exempt) supplies of services for which their new subsidiaries will pay them; and
make sure they produce evidence of that intention dating from before the transaction goes through, such as:
- board minutes;
- engagement letters; and / or
- registering the holding company itself for VAT; and
(unless there are good reasons for that intention to change) ensure they follow through on that intention after they complete the acquisition, by:
- documenting the agreement between the new parent and its subsidiaries for the parent to provide them with management services;
- documenting provision of the services and making and receiving payment; and
- issuing the requisite VAT invoices.
The earlier they focus on this, the better. As BAA shows, delay can be expensive.
The Commission’s infringement proceedings had the potential to be more significant than the BAA case. Had the Commission succeeded, the seven member states concerned would have had to amend their legislation. Taxpayers in those member states would have had to revisit the structuring of their groups as a result. As it is, the Court’s ruling means that VAT considerations should not discourage a group from dividing its operations between subsidiary companies under one or more pure holding companies.
Neither decision is particularly surprising; on balance, that is good news for taxpayers.