VAT update for private equity houses, venture capital firms and portfolio companies

We are aware of several private equity (PE) fund managers receiving “one-to-many” or “nudge” letters from HMRC regarding VAT compliance.

These prompts are intended to encourage taxpayers to evaluate their VAT position and determine whether they require tax advice or need to exercise greater diligence in certain aspects of their tax returns.

These letters focus on:

1. The fair and reasonable attribution of input tax to supplies with a right to deduct under the partial exemption method.
2. The use of taxed inputs.
3. The right to deduct input tax on the disposal of shares upon exiting an investment.
4. The verification of genuine supplies of management services to investment companies.
5. The application of reverse charges.
6. The determination of whether supplies are made in the UK for VAT purposes.

We provide more information on this and what it could mean for PE fund managers below. 

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HMRC has updated its guidance in relation to private equity businesses and is urging such businesses to reassess whether their VAT charging and recovery profiles remain up to date. HMRC’s VAT guidance specific to the sector is detailed in PE79000.

The guidance at PE79000 addresses several key VAT areas for those operating in this sector

1. Input tax recovery on share disposals

Businesses need to ensure they are accurately recovering input tax related to share disposals. This is further to the Court of Appeal’s findings in the Hotel La Tour case. The court concluded that the VAT incurred on the professional costs was irrecoverable as it had a direct and immediate link to the VAT exempt share sale.

2. Partial exemption method

Companies must assess whether their partial exemption method provides a ‘fair and reasonable’ level of input tax recovery. This is particularly crucial for businesses with PESMs agreed with HMRC, as they are responsible for monitoring the fairness and reasonableness of their PESM. We are aware that private equity firms with PESMs that were agreed a number of years ago are being reviewed to establish whether the recovery rates and calculations remain appropriate.

3. Non-business income

Firms should examine if there is any non-business income derived from profit shares and/or dividends. Recovery of VAT on costs related to non-business income should be restricted. This calculation is similar to the standard method of partial exemption; business income as a percentage of total income.

4. Supplies of management services

It is essential to verify whether supplies of management services to portfolio companies can be sufficiently evidenced. Established case law has shown us that simply having a management services agreement in place is not enough to be eligible for VAT recovery. The entity providing management services should demonstrate sufficient substance to effectively deliver these services.

5. Reverse charge mechanism

The correct application of the reverse charge mechanism is a common VAT compliance failing and area of focus for HMRC with Private Equity businesses. The reverse charge applies to most services that have been acquired from overseas vendors. When carrying out a VAT inspection, HMRC often use the proper application of the reverse charge as an indicator of the overall accuracy and health of a business's VAT records.

Given the increased focus on compliance, private equity, venture capital firms, and their portfolio companies should take proactive steps to review and, if necessary, adjust their VAT practices in line with HMRC’s guidance. This will help mitigate potential risks and ensure adherence to current regulations.

For further information on how HMRC’s guidance and new focus on the VAT position of private equity businesses may impact you, please contact Robert Marchant, or your usual Crowe contact.