On 2 August 2019, the First-tier Tribunal held5 that a company could recover input VAT on legal fees incurred by a shareholder/director (Mr McKee) of the company even though the legal fees were incurred (i) prior to incorporation of the company and (ii) in respect of a claim against him by a third party.

Mr McKee, a software programmer, had been engaged as a consultant by Jumar Solutions Ltd (Jumar). During this time Mr McKee developed software in his spare time, outside of his responsibilities with Jumar, and with the intention of developing the software after he had left Jumar. Jumar issued proceeding against Mr McKee in the mistaken belief that he was looking to develop a product that infringed Jumar’s copyright and confidential information. Mr McKee instructed solicitors, personally, to defend the claim and was successful before the High Court in June 2016.

Very soon after succeeding at the High Court, Mr McKee incorporated Koolmove Ltd as a vehicle through which to develop the software as a business. Koolmove became registered for VAT and submitted VAT returns that sought to recover the VAT on the significant legal costs incurred by Mr McKee in successfully defending Jumar’s claim. HMRC wrote to Koolmove, disallowing the recovery of this input VAT, on the basis that “the engagement letter between Mr

McKee and his solicitors do not mention [Koolmove], therefore the legal costs were provided to Mr McKee in his personal capacity as [Koolmove] did not exist at the time of the litigation.”

The appeal to the First-tier Tribunal rested upon the application of regulation 111 of the Value

Added Tax Regulations 1995 (Exceptional claims for VAT relief). In particular regulation 111(1) (b), when read with regulation 111(2)(d), provides that input VAT on supplies made prior to incorporation may be recoverable by a company if:

  • the supplies were made for the company’s benefit and for the purposes of the business to be carried on by it
  • the supplies were made to a person who, at the time, was not a “taxable person” for VAT purposes but who became a member or officer of the company
  • the supplies were made within the 6 months before the company’s effective date of registration, and
  • the cost of the supplies are reimbursed in full by the company.

The Tribunal held that Koolmove could recover the VAT on the legal costs, on the basis that Mr McKee always intended to exploit the software he developed during his time working for Jumar through his own company. The incorporation of Koolmove took place as soon as reasonably practicable after Mr McKee succeeded at the High Court in defending Jumar’s claim, and the Tribunal accepted that it would have made no sense to incorporate the company before the outcome of the High Court case was known.

The decision can be viewed here.