The ability of holding companies to recover VAT on costs incurred continues to be hotly contested by HMRC. As such, organisations must plan in a careful and timely manner to protect their VAT recovery regarding refinancing, restructuring deal transactions, and ongoing operating costs.
There have been several developments in UK and EU case law, and these are summarised below, along with some essential planning points. These decisions provide a 'roadmap' of the steps holding companies should take to ensure they have an economic activity that results in the making of taxable supplies and consequently an entitlement to recover VAT.
The traditional concept of a holding company is a company that acquires and holds shares in subsidiary companies and receives dividends that are outside the scope of VAT. However, such entities can be engaged in several additional activities, actively managing subsidiaries and providing services for consideration.
The nature of those activities will directly affect the holding company’s ability to recover VAT on the costs it incurs.
If a holding company just passively receives dividend income—in that case, it cannot register for VAT in its own right as it is engaged exclusively in non-business investment activity, as demonstrated in the cases of Polysar and Larentia + Minerva. Active trading in shares can be an exempt business activity (noting potential VAT recovery in the sale of shares to overseas recipients when part of a business activity). On the other hand, the mere purchase and sale of shares by a person holding such shares for investment, such as a holding company, is not regarded as an economic activity.
To register for VAT and recover VAT on costs, the holding company must be carrying on a taxable economic activity for VAT purposes. On the assumption that a holding company does not supply services to third parties, in addition to the typical passive, non-business activities undertaken, holding companies could be ‘active’ for VAT purposes via the provision of management services to subsidiaries.
Such services typically cover strategic advice, accounting, administrative, and IT services, which are subject to VAT. Additionally, the leasing of commercial property to a subsidiary would be an exempt business activity subject to an option to tax, as in the case of Marle Participation.
However, it is essential that any such arrangements are well-planned and structured, have substance and a commercial rationale, are genuinely carried out, and are well-documented, as various cases have shown several areas of challenge here.
However, many cases have shown that even where there are agreements for management services to subsidiaries, the practical arrangements have undermined the notion of economic activity. It is important to note that supplying services does not necessarily amount to economic activity. There is a requirement that the service activity is conducted with a degree of regularity and sound business principles.
In the case of MVM, management services were provided, but the subsidiaries were not charged for these; other cases lacked a repayment schedule (African Consolidated Resources) or suggested future payments but did not specify the basis on which the fees were to be charged or when they fell due (Norseman Gold UKUT).
HMRC have sought to show that where payment for management services is contingent on the profitability of the subsidiary’s business, then there is a break in the link between supply and consideration. The notion of contingent fee arrangements was considered by the First Tier Tribunal in the case of Bluejay Mining. In this case, the subsidiary received invoices for services, which were to be settled within 30 days. These invoices were added to the inter-company loan account, which the tribunal viewed as payment of the invoice. The tribunal found that there was nothing contingent about the payments to be made under such contractual arrangements.
The case of Larentia + Minerva showed management charges were made to some subsidiaries but not all, and this raises a question as to whether VAT recovery should be restricted on that basis.
HMRC has historically adopted an inconsistent approach to this matter. But case law and HMRC’s updated guidance show us that a holding company must have the following in order to be eligible to recover VAT on costs:
Since issuing its updated guidance, HMRC has continued to be active in challenging holding companies that, in their view, do not have an economic activity. The comments below are therefore based on our experience, technical principles from case law, and what we know of HMRC’s latest thinking.
VAT incurred on costs can only be recovered by the recipient of the supply. Therefore, it is critical to ensure that supplies are made to the correct entity, as otherwise, the VAT may be irrecoverable. Determining the recipient of a supply is often not straightforward, and care must be taken to confirm the point.
HMRC can ask for copies of engagement letters, invoices (and potentially deliverables) to confirm that the entity that is seeking to recover VAT was the recipient of the services.
Where the holding company is part of a VAT group, it brings some further VAT rules to consider.
HMRC's current policy is that a pure holding company being a member of a VAT group does not, of itself, give rise automatically to an entitlement to recover VAT. This is because being a member of a group cannot change a non-economic activity into an economic activity. Nor does it automatically create a direct and immediate link between the costs of a holding company and the taxable outputs of other VAT group members.
However, there is a distinction for what can be considered 'stewardship costs'. These are costs that are usually incurred by the holding company for the purposes of the VAT group members as a whole and not only for the holding company itself. In most cases engagement letters and invoices are addressed to the holding company, even though those supplies will be for the benefit of the VAT group as a whole (this approach is undertaken as an easement to avoid invoices and contracts with multiple entities). Examples of such costs include, but are not limited to group audit, public relations, legal, and other such services. In cases where VAT has been incurred on these types of costs, the input tax should be treated as incurred for the group and not the holding company. Recovery of this VAT is then based on the activities of the group as a whole.
In light of the various developments in the courts and to HMRC guidance, the following key planning points should be considered:
We will no doubt continue to see further updates to HMRC guidance, as the matter is still very much a subject of challenge. HMRC often takes an aggressive stance due to the large amounts at stake, the varying complexities, and because the cases are very fact-sensitive. Businesses must be aware of these issues and plan at the earliest opportunity.
To discuss this issue further, contact Robert Marchant or your usual Crowe contact.
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