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HMRC internal manual

VAT Input Tax

When is VAT recoverable by holding companies

When a shareholding is used as part of an economic activity?

Is the Holding Company the recipient of the supply

Is the Holding Company undertaking economic activity for VAT Purposes

Shareholding acquired as a direct, continuous and necessary extension

Intention to make taxable supplies

Contingent consideration for management services

The effect of a holding company joining a VAT Group

Stewardship Costs

Mixed economic and non-economic activities

 

The Court of Appeal in the case of BAA noted that there are two conditions for the recovery of VAT. Firstly the tax must be incurred by a taxable person in the course of an economic activity. Secondly the goods and services on which the VAT is incurred must have a direct and immediate link with taxable supplies made by that person. See BAA at VIT64050.

When a shareholding is used as part of an economic activity? {#}

VAT may only be recovered if incurred in the course of an economic activity.

Simply holding shares in order to receive dividends and perhaps to sell them for a capital gain is an investment activity and not an economic activity for VAT purposes. Therefore the VAT on the costs of acquiring and holding shares for either of these purposes is not recoverable. For the VAT to be potentially recoverable the entity acquiring the shares must do so, for some other purpose which is economic.

For example

•Shares may be acquired and held temporarily as part of an activity of trading in securities. Trading in securities differs from investment in securities because the aim is to profit from short term movements in the price rather than the long term growth. A profit can be made regardless of whether the shares are increasing or decreasing in price. Trading in securities is an economic activity.

•A company may acquire and hold shares in subsidiaries to which it intends to provide management services for consideration. The provision of services for consideration is an economic activity.

Following the CJEU decision in the joint cases Larentia +Minerva and Marenave (L+M) HMRC reviewed its existing policy in respect of holding companies and deduction of VAT incurred on acquisition costs. Prior to L+M our policy was that VAT incurred on costs of acquiring shares by a holding company was only deductible where it was directly attributable to the provision of taxable management or technical services. VAT incurred had to be apportioned between non-economic activity of shareholdings and economic activity. Additionally, VAT on costs incurred by a holding company was only recoverable if the intention was to recoup the expenditure from the income resulting from taxable services provided to subsidiaries within a reasonable time.

In L+M the CJEU held  that VAT incurred by a holding company on the costs of acquiring shareholdings in subsidiaries, to which it also intends to provide taxable management services, must be regarded as belonging to the Holding company’s general expenditure and is deductible subject to any Partial Exemption restriction in place.

In order to be able to deduct VAT incurred on costs of acquiring shareholdings in subsidiaries the following conditions must be satisfied:

  • the holding company making the claim must be the recipient of the supply
  • the holding company must be undertaking economic activity for VAT purposes
  • that economic activity must involve the making of taxable supplies.
  • If the holding company is VAT grouped with its subsidiaries, it makes taxable supplies or loans for which it earns interest and the loans support the making of taxable supplies by the VAT group.

If the holding company is not the recipient of the supply, or is not undertaking economic activity, it will not be able to recover VAT.

Is the Holding Company the recipient of the supply

 HMRC consider that a holding company is the recipient of the supply where it has contracted for the supply, including by novation and it has made use of the supply, been invoiced and paid for the supply.    

Is the Holding Company undertaking economic activity for VAT Purposes

In addition to an activity which any other business may undertake (supplies of goods and services more generally), the holding company is undertaking economic activity for VAT purposes where it makes or intends to make supplies of management services for consideration, to its subsidiaries.

It is important to note that the management services must be genuine and provided for consideration which is more than nominal.

Where the Holding company is passive with no economic activity of its own, any VAT incurred on the costs of acquiring subsidiaries is not recoverable, and this will still be the case if the holding company joins a VAT group with the acquired companies.

For VAT to be recoverable, the costs on which it is incurred (including acquisition costs) must have a direct and immediate link to taxable supplies conducted as part of the economic activity.  VAT will only be recoverable to the extent that  those costs are used for the taxable activity. For more on the meaning of the term direct and immediate link see VIT21000

If a holding company provides taxable management services, to all its subsidiaries, then any VAT incurred on acquisition costs relating to the holding in those subsidiaries will be deductible. The receipt of dividends does not affect the deduction.

However, if a holding company incurs costs on acquiring shares in subsidiaries intending to make taxable supplies to some of them, but not others, the acquisition of the latter subsidiaries is an investment activity and not an economic activity for VAT Purposes.  Accordingly, the VAT incurred should be apportioned between the economic activities and the investment activities.

Alternatively a holding company may incur costs on acquiring shares in a subsidiary to which it both provides management services and makes a loan in respect of which it earns exempt interest. In those circumstances any VAT incurred on costs relating to the holding must be apportioned between the taxable and exempt supplies in line with the company’s partial exemption method.

Shareholding acquired as a direct, continuous and necessary extension

If the shareholding is acquired as a direct, continuous and necessary extension of a taxable economic activity of the holding company, the VAT incurred may also have a direct and immediate link to taxable supplies and be recoverable.

For example

  • A retail company incurs costs acquiring a subsidiary whose main asset is a property from which the retail company intends to trade. In these circumstances the acquisition of the shares may be an extension of the retail business rather than an investment. If this is the case, the costs of acquisition are likely to be cost components of the retail supplies to be made from the property. The shares were acquired in order to obtain the property for the retail business. The VAT incurred will be recoverable to the extent that the retail supplies are taxable.

  • A business acquires a direct competitor, a similar and complementary business or a key supplier/customer with a view (as the case may be) to increasing market share, achieving economies of scale, or achieving efficiencies through greater integration of its supply chain.

In the above examples the shareholding is a direct, continuous and necessary extension of the existing business activity. There is no need for a specific supply (e.g. management services provided to the acquired business) to link the VAT costs to the existing economic activity.

This is to be contrasted with:

  • A company which purchases a business as a free-standing enterprise with a view to making money on dividends or an eventual sale.  

In the first two examples the buyer is buying to strengthen its business, but by contrast in the above example there is no direct link between the acquisition and its own business and the acquired business does not itself benefit by being part of a larger, similar operation.

The VAT on costs incurred by the target of an acquisition,  such as vendor due diligence costs, may also be deductible provided it can be shown that the target is the recipient of the supplies in question and those supplies were received for the purposes of the business carried out by the target.  

Intention to make taxable supplies

If a holding company recovers VAT on acquisition costs because it intends to make taxable supplies to the subsidiary, it should retain evidence to demonstrate that this was the intended business model. 

Where a holding company can evidence a genuine intention to make taxable supplies to its subsidiaries but those services are not actually made then the normal input tax rules regarding intention to make supplies will apply.  See VIT22000

Contingent consideration for management services

Where a holding company incurs input tax on costs in providing or intending to provide management services to subsidiaries on terms whereby any payment will be contingent upon the profitability of those subsidiaries, then the holding company is not engaged in economic activity.   This is because where services are supplied for no consideration or there is no contractual expectation that consideration will be received there is no supply for VAT purposes.

The supplies in question are not being provided for a consideration because the essential direct link and reciprocity between the obligations on the one hand of the holding company to provide the management services and the obligations on the other of the subsidiaries to make a payment for those services, is absent.

The issue of what constitutes a supply for a consideration has been the subject of a substantial body of case law.  Most recently we have the decision of the Upper Tribunal in the case of Norseman Gold see VIT64050

Both the FTT and the Upper Tribunal on appeal considered the adequacy for the purpose of making taxable supplies of an intention to charge at some time in the future for services being provided. The FTT concluded that this would be insufficient in the absence of evidence of any agreement about the amount to be charged, the frequency with which invoices would be sent and the details of the services to be provided in exchange for the charge. It decided that it was important that the price or consideration is stipulated rather than there being ‘a rather vague intention to levy an unspecified charge, at some undefined time in the future’.

The recent CJEU decision in the Hungarian case of MVM see VIT64050 reinforces the above decisions. It also supports HMRC policy following L+M in that the holding company has economic activity only  if it provides genuine management charges under an agreement to charge for those services and does actually charge fees and receive consideration for those services.

 

The effect of a holding company joining a VAT Group

Joining a VAT group does not, of itself give rise automatically to an entitlement to recover VAT. It cannot change a non-economic (i.e. out of the scope) activity into an economic activity. Nor does it automatically create a direct and immediate link between all input costs of a holding company and the taxable outputs of other VAT group members unless such a link can be traced through the intra group supplies, or the input costs are such that they are properly and naturally attributable to the VAT group’s taxable outputs.

VAT grouping has the effect that all supplies are treated for VAT purposes as made to and by the representative member and imposes joint and several liability on all the members.  It doesn’t have any other effect.  If a member of a VAT group incurs costs which it uses for non-economic activities, then the VAT on those costs still relates to the non-economic activities and VAT grouping does not change that.  The supplies are treated as being used by the representative member for non-economic purposes.

In Commission v Ireland C-85/11, the court accepted the opinion of the Advocate General in its entirety. The Advocate General commented at para 43:

the right of the persons belonging to the VAT group to deduct VAT for purchases is not expanded. This right continues to be applicable only to those supplies that are made for the activities subject to VAT by the VAT group. Nor are the members of a VAT group entitled to deduct VAT on supplies made for VAT exempted activities”

It does not make a difference whether the acquirer was already part of the VAT group or VAT groups on acquisition of the target; the right to deduct VAT on the costs cannot be different.

If the cost is received by the VAT group for the purposes of the holding company and the holding company doesn’t undertake economic activity, then it won’t be able to recover the related VAT.  

If costs incurred have a direct and immediate link to taxable supplies made by the holding company  outside the VAT group, the related VAT will be recoverable to the extent those costs are used for that purpose.

If the holding company provides management services or loans in respect of which it earns interest (see VIT64050 EDM C-77/01) to the companies acquired in the VAT group and these can be seen to support the making of taxable supplies by the VAT group (identifiable by ‘looking through’ the supply chain within the group), the related VAT will be recoverable to the extent that the costs support taxable supplies made. This is the case whether the transactions within the group would be taxable or exempt supplies, were they not disregarded because of the VAT grouping.

It is use that determines whether input tax is deductible and the existence of a direct and immediate link between the cost and the taxable supply. The question to ask is ‘has the VAT group incurred the costs for use in its economic activity?’.

Stewardship Costs

It is important to determine whether the supplies are received by the group for the purposes of the holding company’s activities, or for the purposes of the VAT group as a whole. Some supplies may be invoiced to the holding company for convenience (generally referred to as stewardship costs), even though they are for the purposes of the group as a whole. The most common examples are the general audit fees of the group, regulatory compliance, brand defence, bid defence and group legal costs. In those circumstances any input tax incurred should be treated as a cost of the group as a whole, rather than as a cost of the holding company.

Mixed economic and non-economic activities

A holding company may be involved in carrying out both economic and non-economic activities. In such cases VAT recovery is only allowable to the extent that the costs on which the VAT is incurred are attributable to taxable supplies which are intended to be made in the course of an economic activity.  

L+M endorsed the court’s decision in *Securenta C-437/06 *that where the holding company holds shares in subsidiaries in which it has no involvement ( which does not constitute an economic activity) and also has shares in subsidiaries to which it provides management services for consideration (and which therefore does constitute economic activity) the costs should be apportioned according to use.