New guidance recently published by HM Revenue and Customs (HMRC) highlights how important it is for groups with holding companies to review their right to reclaim VAT. The guidance follows in the wake of the Court of Appeal's 2013 decision in BAA plc which looked at whether a holding company was entitled to recover VAT it had incurred in buying the BAA airports business.
The guidance also comes soon after the German courts referred several questions to the Court of Justice of the European Union (CJEU) in the cases of Larentia + Minerva and others about the extent to which holding companies may recover VAT. The CJEU’s decision, expected within 18 months, may further affect how UK holding companies need to determine VAT recovery.
The Court of Appeal’s decision in BAA
In 2006, a consortium set up a new holding company, ADIL, to bid for, and ultimately buy, the BAA group. ADIL incurred almost £7 million VAT on services it received in the course of bidding. After it completed the deal, ADIL joined BAA’s VAT group which then claimed the VAT from HMRC. The claim was rejected by HMRC.
The Court of Appeal agreed with HMRC’s position since ADIL could not prove to the Court’s satisfaction that:
- It intended to perform an economic activity at the time it engaged service providers
- There was a direct and immediate link between the services ADIL received and the taxable supplies which the BAA VAT group made.
ADlL’s problems with VAT recovery occurred partly because of the way it structured the acquisition and also from its failure to retain evidence of its intentions at the time they were formed.
The Latest Position on Holding Company VAT Recovery
The difficulty for holding companies in reclaiming VAT on their costs dates back to the 1994 Polysar decision when the CJEU ruled that merely holding shares is not an economic activity and does not entitle a company to VAT-register or reclaim VAT.
Many cases on related issues then followed. With its latest guidance, HMRC indicates it will pay closer attention to holding company activities. Although pure holding companies are not entitled to recover VAT, most holding companies achieve partial, if not full, VAT recovery by making taxable supplies of management services to their subsidiaries in return for fees.
Uncertainty remains, however, over the extent to which a holding company making taxable supplies must attribute VAT on its costs to shareholding activities rather than to managing subsidiaries. The CJEU has in the past, notably in Cibo Participations SA from 2001, ruled that ‘expenditure incurred by a holding company in respect of the various services which it purchases in connection with the acquisition of a shareholding in a subsidiary forms part of its general costs and therefore has, in principle, a direct and immediate link with its business as a whole’. Despite this, HMRC is still likely to challenge VAT recovery on costs which they consider related only to buying or holding shares. Its new guidance states that VAT will be recoverable only if a holding company can demonstrate that:
- There is a direct and immediate link between the services received and the management of its subsidiaries.
- The management charges are intended to allow the holding company to recoup its costs within a reasonable period – say five to ten years.
Many holding companies, especially those managing fully-taxable operations, belong to a VAT group along with some or all of their trading subsidiaries. VAT groups can include entities that are not economically active, such as pure holding companies. In fact the UK, along with several other member states, successfully defended this right last year after the EU Commission had argued that businesses should not be able to join a VAT group if they would not be eligible to VAT-register in their own right.
A VAT group is treated as one single entity for VAT purposes which means filing one VAT return for the group. Most supplies between VAT group members are disregarded for VAT purposes. This in principle sounds useful for holding companies seeking to recover VAT on their costs; it is tempting to assume that including a holding company in a VAT group with trading entities is a panacea for VAT recovery issues.
However, VAT grouping alone does not permit a holding company, or any company for that matter, to reclaim VAT; recovery is only possible where costs are directly and immediately linked to taxable supplies made by the VAT group. In most cases, this means demonstrating that a holding company actively manages trading companies, in the same way as described above. Without that management link, the holding company’s costs may need to be attributed to shareholding activities which will not allow VAT recovery.
The CJEU’s decision in Larentia + Minerva and others will hopefully clarify how businesses should deal with VAT recovery on holding company costs. In the meantime, businesses intending to buy other companies should consider three points:
- Management charges made by a holding company to subsidiaries do not necessarily mean that the holding company is entitled to full VAT recovery:
HMRC may challenge VAT recovery by a holding company on the grounds that at least part of the holding company’s activity is linked to non-economic shareholding and investment activity.
- VAT-grouping a holding company with taxable subsidiaries does not in itself entitle the VAT group to full VAT recovery on holding company costs:
Even though a VAT group is treated as a single entity for VAT purposes, costs still need to be directly and immediately linked to the group’s taxable activity. Businesses need to ensure their holding companies are actively managing trading subsidiaries and do not view VAT grouping as a shortcut to securing VAT recovery.
- The level of management charges is important:
HMRC states in its guidance that if a holding company incurs costs relating to its subsidiaries’ businesses, the holding company should receive enough income from its management activities to recoup those costs within, at most, ten years. The implication is that, if a holding company does not intend to recoup its costs via management charges over a reasonable period of time, the holding company will bear the costs partly or entirely from non-taxable income; this, in HMRC’s view, would not entitle the holding company to recover VAT in full.
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lclark [at] alvarezandmarsal.com (Leigh Clark)
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For additional information:
- Alvarez & Marsal Taxand’s recent article VAT Recovery by Holding Companies in the EU published in Bloomberg BNA.