When businesses undertake a major corporate acquisition, the normal procedure is to set up a holding company (‘HoldCo’) to undertake the acquisition and hold the shares following the acquisition. HoldCo will incur all the professional fees and will manage the trading company, but recovering the VAT on the costs can be a problem if you do not structure the recharges correctly.
Problems with HMRC
HMRC are increasingly challenging the commerciality of arrangements that are in place to recover VAT incurred on transaction fees, following their success in the Court of Appeal (BAA Ltd v HMRC [2013] STC 752).
HMRC’s view is that VAT should only be recoverable on inputs associated with a share acquisition if the taxable supplies Holdco intends to make to the trading company will enable it to recover its acquisition costs within five to ten years. HMRC’s internal guidance says:
‘HMRC are likely to challenge claims that the costs are to be recovered over timescales which would not allow the capital expenditure to be recouped for many years.’
HMRC’s view of the law is controversial, and many tax experts would disagree with it. To obtain a refund of input VAT on transaction costs, HMRC argue that the arrangements put in place between Holdco and the target company (‘Target’) should be commercially justifiable. If a return on capital is not expected within five to ten years, HMRC consider that the costs were incurred in connection with the passive activity of holding shares and receiving dividends, rather than in connection with any taxable activity. If this is the case, HMRC will disallow the input tax on the basis that it does not relate to a business activity.
Commercial arrangements
Businesses should therefore avoid putting in place a standard management services agreement on completion of the acquisition that bears little resemblance to the intended ongoing relationship between Holdco and Target. Such an arrangement could be construed by HMRC as a smokescreen for VAT recovery. Careful thought should therefore be given to how Holdco can assist Target and which services it can provide; either from its own resources or through providing services from third-party advisers.
In most cases, even if a business disagrees with HMRC’s view of the law, most will endeavor to develop structures that ensure as much VAT as possible is recoverable in accordance with HMRC guidelines.
However, there will be times when such structures are not possible and a holding company will not be able to provide services that have an arm’s-length value large enough so that it can recover its input costs within five to ten years.
Disbursements
When such instances arise, HMRC’s guidance should be considered in the light of an ECJ Judgement (Cibo Participations SA v Directeur Regional des Impots du Nord-Pas-de-Calais (Case C-16/00). The ECJ ruled that the relevant expenditure incurred by the holding company in relation to the share acquisition was directly linked to its business and formed part of its general overheads. If the only outputs that the holding company made was taxable, it should be able to recover all of the input VAT it had suffered (irrespective of the value of the taxable services it was intending to provide to the new subsidiary).
On that basis, it would be incorrect for HMRC to require that taxable outputs are at such a level that input VAT is recoverable within any defined period.
Practical Tip:
If you are undertaking the accquisition of a company, you should try and ensure the intercompany charges are commercial and costs can be recouped within five to ten years. If this cannot be done and HMRC challenge you, you have ECJ support for recovering the VAT if you are fully taxable.
