The recovery of VAT on deal-related costs remains one of the most complex and frequently disputed areas of the UK VAT system.
For businesses involved in M&A, restructurings, or disposals, the ability to recover input VAT can significantly influence transaction pricing, investment returns, and overall deal economics. This article outlines the key legal principles, highlights areas of risk, and sets out practical steps to enhance VAT recovery.
Legal framework for VAT recovery
VAT recovery is governed by two key legal conditions derived from UK VAT law and case law:
- whether the costs relate to an economic activity
- whether there is a direct and immediate link between the expenditure and taxable supplies.
To recover VAT, a business must demonstrate that:
- the relevant activity constitutes an ‘economic activity’ for VAT purposes. Passive shareholding alone does not qualify
- the expenditure is incurred to make taxable supplies or support an overarching taxable activity
- the entity claiming recovery is the true recipient of the supply, determined by contractual arrangements, invoicing, and substance.
Failure to meet any of these conditions may render VAT irrecoverable, even if the wider business makes taxable supplies.
HMRC’s approach to holding companies
Holding companies are frequently used to incur deal costs but face heightened scrutiny due to their structural position and often limited direct activity. HMRC distinguishes between two types.
Passive holding companies
These entities hold shares and receive dividends without undertaking economic activity. VAT on associated costs, including acquisition or disposal fees, is irrecoverable.
Active holding companies
Active holding companies do not trade with 3rd parties but instead provide taxable services (e.g. management, administrative, or technical services) to subsidiaries for consideration. VAT recovery may be available where genuine taxable activity is established and evidenced through:
- a management services agreement (MSA) in place at or before acquisition
- regular invoicing and evidence of payment
- timely VAT registration
- demonstrable substance, including personnel and actual service provision.
Where such evidence is absent, HMRC is likely to challenge VAT recovery.
We cover everything you need to know about VAT recovery by holding companies.
Recent case law: Hotel La Tour
Hotel La Tour has become one of the most significant modern cases on VAT recovery for fundraising transactions. Earlier judgments in this litigation had suggested that recovery may be available where share disposal proceeds were used to fund downstream taxable activities. However, the Court of Appeal and subsequently the Supreme Court rejected this approach.
The Supreme Court confirmed that VAT incurred on professional fees directly linked to an exempt share sale is irrecoverable, regardless of how the proceeds are used. This reinforces a strict application of the “direct and immediate link” test and confirms that intended future use of funds is irrelevant where costs are attributable to an exempt transaction.
We cover further information on the Hotel La Tour VAT case.
Buy side vs sell side VAT recovery
Differentiating between buy-side and sell-side costs is critical in determining the correct VAT recovery position, as the classification directly affects whether input tax can be reclaimed. Accurately identifying and evidencing the nature and purpose of these costs is therefore essential to ensure compliance with VAT principles, minimise the risk of challenge from HMRC, and optimise the VAT recovery position.
Buy side deal costs
Buy side costs include due diligence, advisory, structuring, and financing expenses. VAT recovery is only available where the acquiring entity is undertaking or intends to undertake a taxable economic activity.
Acquiring shares purely for investment does not qualify. Businesses seeking recovery must demonstrate that the acquiring entity will provide taxable services to the target, supported by:
- a contemporaneous MSA
- VAT registration
- charging and invoicing arrangements
- evidence that services will genuinely be delivered.
If these elements are missing or only established after the transaction, HMRC may argue that no economic activity existed at the relevant time, denying recovery.
Sell side deal costs
Sell side costs are generally more problematic. The sale of shares is an exempt supply, meaning VAT on costs directly linked to that sale is typically irrecoverable.
Further challenges arise where shareholders, rather than the company, are the sellers. In such cases, advisory services are supplied to the shareholders personally, and the company cannot recover VAT even if it benefits commercially.
However, a different outcome can be achieved where the share disposal is made to a non-UK customer. Supplies of shares to non-UK customers can be treated as exempt supplies with credit under UK VAT law, meaning that input VAT directly attributable to those supplies may be recoverable.
The position may differ in asset sales or where a transaction qualifies as a Transfer of a Going Concern (TOGC). Depending on the specific facts, such transactions may fall outside the scope of VAT or be connected to taxable activities, potentially allowing input tax recovery. However, TOGC treatment is highly fact-dependent and requires careful analysis.
Common pitfalls and how to strengthen recovery
In our experience, businesses often encounter difficulties due to:
- late or backdated MSAs undermining evidence of intent
- failure to invoice or charge for services
- incorrect identification of the recipient of supply
- missing documentation, including payment evidence
- poorly structured VAT group arrangements.
Businesses should take a structured approach to VAT recovery throughout a transaction. This means planning early, aligning contracts with the intended VAT treatment, and keeping clear supporting evidence. Invoicing, payment flows, and operations should also match the VAT position to ensure it is consistent and defensible if challenged by HMRC.
Conclusion
VAT recovery on deal fees remains a high-risk area requiring careful structuring and robust evidence. The Supreme Court decision in Hotel La Tour confirms that a strict interpretation of the “direct and immediate link” test will be applied, with limited scope to rely on broader commercial context or intended use of funds.
Businesses should prioritise early planning, clear contractual arrangements, and comprehensive documentation to maximise recovery and mitigate risk. A proactive approach and technical rigour are essential in navigating this complex area effectively.
For further information, please reach out to your usual Crowe contact.
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