UK holding companies working in the natural resources sector continue to face challenges when recovering UK VAT. We still recommend that organisations proceed with caution, however, a recent ruling at First Tier Tribunal (FTT) in favour of Tower Resources plc against HMRC could be a sign of good things to come.
It is common for businesses in the sector to have a UK holding company to attract investment with an office that employs a number of senior management, legal and financial staff, but with the exploration/revenue generation asset owned in another company. The challenge for VAT recovery is that the VAT rules focus on the activity of the UK holding company and not the (intended) activities of the overseas subsidiary. If the holding company doesn’t make sales of its own, or charge its subsidiary for management services, it is unlikely to be able to register and reclaim VAT.
In recent years, there has been a number of disputes that have reached the VAT courts with many of the decisions being in favour of HMRC. However, in news that is likely to be welcomed by many, last month the FTT found in favour of the taxpayer Tower Resources plc in concluding that it had an economic activity and was entitled to recover UK VAT.
Tower Resources plc (TR) is a UK VAT registered holding company that acquires licences to explore and produce oil in sub-Saharan Africa. At the time a licence is obtained there is the hope and expectation that it will succeed, even though perhaps just 1 in 5 exploration wells are ultimately successful.
The activities in each country are carried out through local subsidiaries. The subsidiaries do not operate independently of TR, which remains the signatory and guarantor of each licence operated under by the subsidiaries. The subsidiaries obtain the bulk of technical services and fund local costs.
As often seen with holding companies, TR has at least one common director with its subsidiaries and the chief executive officer of TR is a board member of each subsidiary.
When TR covers the costs of its subsidiaries, instead of issuing invoices to its subsidiaries it would add to the intercompany loan accounts. Initially the values were added to the loan accounts at cost. However, since April 2015 a 5% mark-up was added.
There was no evidence of repayment, in part or in full, from the subsidiaries to TR. However, the intercompany loan accounts were treated as assets in TR’s accounts and as liabilities in the subsidiaries' accounts. The loans were also substantiated by written agreements for part of the period in question.
Despite there not having been any repayment by the subsidiaries, the loans were treated for accounting purposes as repayable on demand, rather than being an unspecified charge payable at some undefined time in the future.
HMRC raised assessments going back as far as June 2012, and denied input tax for more current periods, when it realised that the exploration licences were held in non UK subsidiaries and it was therefore the subsidiaries that undertook the exploration activities and not TR.
HMRC claimed that TR was not making taxable supplies for consideration, and if it was decided that there was consideration, then TR was not carrying out an economic activity.
The FTT first considered the contractual position between TH and the subsidiaries and found that agreements for the services rendered and the loans did exist, despite the initial period when an agreement was not formalised in writing.
The agreement was evidenced by the accounting treatment of the loans and the audit reports covering the period in question, and these reflected the commercial and economic reality of the relationship between them.
Looking at HMRC’s claim that there was uncertainty of payment breaking the direct link between supply and consideration, with an attempt to invoke Norsemen Gold Plc, the FTT noted that TR not only intended, but did charge its subsidiaries for the services that it provided to them.
"There was a legal obligation on the subsidiaries to make payment on demand in relation to the intercompany loans, the fact that it was not discharged does not mean that there has not been consideration for the relevant supply”.
As a result, TR did make supplies to its subsidiaries for consideration.
The FTT then went on to consider whether TR made supplies in the course of an economic activity. Drawing mainly from the Wakefield College case the FTT noted that this requires a wide ranging, not a narrow, enquiry in which all the objective circumstances in which the goods or services are supplied must be examined but does not include subjective factors such as whether the supplier is aiming to make a profit.
The FTT made an effort to address each of HMRC’s points contesting economic activity. Ultimately, it relied on the EU precedents of Cibo and Larentia to arrive at the following statement:
“…[a] finding that [the] holding company was supplying services to its subsidiaries for consideration…must lead inexorably to the conclusion that the holding company is also carrying on an economic activity”
As a result TR’s appeal was allowed.
Further background can be found in our previous alert - February 2019.
Input tax recovery by holding companies is a complicated ever-changing area of VAT and one which continues to be an area of focus for HMRC.
This decision goes against HMRC's established position of requiring written evidence of the services provided and cash settlement of invoices, but HMRC may well seek to distinguish it on the basis that it is a First Tier decision only and not binding on other parties. Although HMRC were unsuccessful in this particular case, the differences between this case and those that have failed are nuanced and careful planning is required to give your business the best chance of safeguarding its VAT position. Any business facing these challenges should consider getting advice.