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HMRC internal manual

VAT Taxable Person Manual

HM Revenue & Customs
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Particular trades: shell companies

The problem

To reduce its corporation tax liability, a principal company with one or more trading subsidiaries may transfer the business, assets, and liabilities of those subsidiaries to itself. The principal company therefore becomes the main trading company, and both makes and receives supplies which were formerly made or received by the subsidiaries; the subsidiaries become empty ‘shells’.

When this situation develops, there is a danger that both principal and shell companies may continue to account for tax as they always have done - with the shells making full VAT returns and paying or reclaiming VAT. Whilst this will not cause a direct revenue loss, it does constitute a revenue risk; if the shells get into financial difficulties enforcement action cannot be taken against companies which are not making supplies and have no assets. Therefore you need to firstly, correctly identify a shell company situation, and secondly, ensure that where this exists, both principal and subsidiaries account for tax correctly.

How to identify a shell company

When a shell company situation develops, a subsidiary will contract so as to make no trading supplies. It will also dispose of its assets and the majority of its staff; although it may retain one or two accounting staff to keep its few remaining books and records. All these indicators will best be discovered by examination of the annual accounts.

Sometimes a subsidiary may transfer its business, liabilities, and assets other than staff to the principal company, but continue to employ staff and supply their services to the principal. In this situation, the principal company must account for tax on sales to third parties, using one of the options described under Correct accounting procedures below. But the subsidiary is still making taxable supplies to the principal company, and must account for tax (subject to the normal registration limits) unless it is incorporated, with the principal company, into a group registration.

Correct accounting procedures

If you are satisfied that a shell company situation exists, the principal company must account for VAT on supplies to third parties. This can be achieved in one of the following ways.

  • The principal invoices its customers direct - The shells must deregister (see section 13 of VATREG) unless they supply services: see How to identify a shell company above.
  • The principal applies for a group registration to cover both itself and the shell companies See section 54 of VATREG.
  • The principal company uses the shell companies as agents and adopts the provisions of section 47(3) of the VAT Act 1994 (see VTAXPER37900). The principal company issues tax invoices to the shells; in the same tax period the shells reclaim input tax and then issue tax invoices to the same value to the third parties. Shell companies thus make nil returns unless they supply services: see How to identify a shell company above.

Where no revenue loss has occurred, matters may be corrected from a current date. However, a principal company must choose one of the above courses of action. Some principals may offer a security payment in return for our agreement to the continuation of previous practice. You should reject these offers; HMRC cannot condone a practice which it knows is not in accordance with the law.

The shell company diagram (Word 30KB) shows in diagrammatic form how to identify the correct accounting procedure. Alternatively, you may find it easier to follow the following tabular version.

Tabular version of the shell company diagram

Question 1 Have the business assets other than staff and the liabilities of the subsidiary companies been transferred to the principal company? Yes - go to question 2.
No - Subsidiaries continue to trade in their own right.    
  Question 2 Do the subsidiaries provide staff or other services to the principal company? Yes - go to question 3.
No - Subsidiaries have become shells and no longer make taxable supplies. If the principal decides to take option 1 below, then the subsidiaries must deregister.    
  Question 3: Principal must choose the following options. Option 1 Invoice the customers direct and account for output tax - subsidiaries must charge the principal company output tax.

Option 2 Form a group registration with the subsidiaries.

Option 3 Use the subsidiaries as agents and adopt section 47(3). Principal invoices subsidiaries and declares output tax. Subsidiaries reclaim input tax and declare output tax on sales to customers to the same value and in the same tax period.