Everything FDs need to know about VAT recovery on deal costs

Businesses have always been challenged by Her Majesty’s Revenue & Customs (HMRC) over the VAT recovery of deal costs.

A degree of uncertainty has existed for some time following various high profile VAT cases. As most Finance Directors (FDs) know, this is an area where the amount of VAT at stake for the business could be substantial, so getting the VAT recovery treatment correct can be critical for the business.

In a welcome move for businesses and advisers alike, HMRC have recently published internal guidance that outlines their policy on the VAT recovery of deal costs for holding companies.

Here’s everything you need to know about it.

HMRC conditions
Taking into account recent case law, the latest guidance sets out the key conditions that holding companies must meet to be entitled to VAT recovery. The holding company must:

1. Have an “economic activity”
2. Have contracted for the supply (or had the contract novated to it)
3. Have used and paid for the supply
4. Have a VAT invoice addressed to them

So what do these conditions mean in practise?

Management charges
HMRC have confirmed that, in addition to any other business activities it may undertake, the holding company will have an economic activity where it makes or intends to make (this needs to be evidenced) supplies of management services for consideration, to its subsidiaries.

It is worth noting that any management services must be genuine and be for more than a nominal amount.

In addition, any management charges that are contingent on the future profitability of the subsidiaries will not entitle the holding company to VAT recovery.

If not all subsidiaries are charged management charges, the VAT recovery must be apportioned accordingly.

Loans to subsidiaries
Although the provision of loans will also form an economic activity, this is an exempt supply and does not, in itself, allow for VAT recovery unless the supplies are made from within a VAT group.

Direct and immediate link
HMRC have confirmed that, for VAT to be recoverable, the costs on which it is incurred, including acquisition costs, must have a direct and immediate link to taxable supplies conducted as part of the economic activity.

VAT will only be recoverable to the extent that those costs are used for the taxable activity. Therefore, if a holding company is providing loans to its subsidiaries, it will not be entitled to VAT recovery, as this would be an exempt supply.

If a holding company provides taxable management services to all its subsidiaries, then any VAT incurred on acquisition costs relating to the holding in those subsidiaries will be deductible.

VAT grouping
It should be noted that joining a VAT group does not, of itself, automatically give rise to an entitlement to recover VAT.

It does not create a taxable activity or create a direct and immediate link between all the input costs of a holding company and the taxable outputs of other VAT group members.

A link should exist between the holding company and the other VAT group members so that the costs are properly and naturally attributable to the VAT group’s taxable outputs.

This can be through the provision of management charges or loans, as long as the loans support the making of taxable supplies by the holding company to the subsidiaries.

Extension of taxable activities
HMRC have confirmed that it is not always necessary for a holding company to make management charges to its subsidiaries.

This applies where a shareholding is acquired as a continuous extension, including buying a similar business or a complementary one, of a taxable activity and that taxable activity is to continue.HMRC have agreed that this can have a direct and immediate link to those activities and be recoverable.

If the transaction involves a company to be purchased as an investment, the holding company must make, or intend to make, supplies of management services to its subsidiaries in order to be in a position to attribute these costs to a taxable supply and enable VAT recovery.

Summary
HMRC have relaxed their positon slightly and it is reassuring that VAT recovery can be achieved more easily than before – as long as certain steps are taken.

The key step for FDs will be to ensure that any bid vehicle, (future holding company), will have a taxable economic activity or will provide loans to subsidiaries as part of a VAT group, and that this can be evidenced at the time the costs are incurred.

It is also important that the intention to make supplies is actually fulfilled in due course, otherwise HMRC may still query the original VAT recovery at a later date.

Many FDs may have chosen not to reclaim any VAT on deal costs for their business as a result of the uncertainty, or may have previously restricted their VAT recovery unnecessarily, to ensure that there wasn’t a risk of potential challenge from HMRC.

For these businesses, this is now an opportune time to reconsider the VAT treatment that has been adopted for the last four years and to review whether it may be possible to recover any of the VAT that was originally restricted.

FDs who are involved in corporate finance transactions should take advice on their VAT position at an early stage, to ensure that they are maximising the possible VAT recovery of their deal costs.

Kamlesh Chauhan is a senior manager at haysmacintyre.