Much is written on VAT and holding companies partly because of the plethora of cases, and partly because, for the tax practitioner, the area brings out some important principles, relevant not only to holding companies, but to input VAT recovery generally.
Also, for groups striving for efficiency and cost saving measures in this age of austerity, all efforts must be made to recover VAT on costs, to the greatest extent possible.
This area of VAT law is unlikely to become settled soon because it is so fact sensitive and applying the legal tests is not straightforward. This article aims to update the reader on recent developments and offers some practical strategies on recovery.
Criteria for recovery
There are three questions which must be answered affirmatively for a holding company to cover VAT on its costs:
Taxable person carrying on an economic activity
On the first question, Polysar (Case C-60/90) decided that the acquisition and holding of shares as an investment activity was not an economic activity. Receiving dividends and making capital gains, merely results from ownership, Larentia + Minerva (Cases C-108 and C-109/14). In contrast, holding shares for the short term, to trade, is an exempt business activity (article 135(1)(f) of the Principal VAT Directive). It should be noted that where the share sale is to a non-EU recipient, the supply is exempt with input VAT recovery, in accordance with the VAT (Input Tax) (Specified Supplies) Order, SI 1999/312, subject to satisfying the use test in reg 103 of the VAT Regulations, SI 1995/2518.
Management services as an economic activity
A holding company will however be involved in a taxable economic activity if it has direct or indirect involvement in the management of its subsidiaries for a consideration (Cibo Participations SA (Case C-16/00) and Floridienne (Case C-142/99)). An economic activity involves not only supplying services for a consideration but also for the purposes of obtaining income on a regular basis (PVD article 9(1); Wakefield [2018] EWCA Civ 952). Management is very widely defined, and includes any transaction subject to VAT, including administrative, accounting or information technology services, even including the leasing of property to a subsidiary (Marle Participations Sarl (Case C-320/17)).
It is important to have management agreements in place, so there is objective evidence, documenting the actual services to be provided by the holding company, and the consideration for those services. That consideration should be calculated on a proper basis, invoiced and paid by the holding company, and the services of course must be genuinely carried out. Norseman Gold [2016] UKUT 69, followed by W Resources Plc [2018] UKFTT 746, held that a vague intention to levy unspecified charges, at some undefined time, when the subsidiaries can afford it, is not sufficient to constitute supplies for consideration. Further, the CJEU in MVM (Case C-28/16) held that not levying intra-group management charges, in the knowledge that there would be dividends and an increase in the value of the corporate group resulting from good management by the holding company, was insufficient to constitute a taxable activity.
Dividends are outside the scope of VAT, and HMRC now accepts that their receipt does not restrict VAT recovery if taxable management services are being provided. It is essential that following a corporate acquisition, management services are rendered by the holding company to all the relevant subsidiaries; if some subsidiaries are not receiving taxable services, the VAT on the costs of acquiring the subsidiaries will be restricted, as held in Larentia + Minerva, which led to the change in HMRC policy.
Holding company as recipient of supply
The second criterion is that the holding company must be the recipient of the supplies on which the input VAT recovery is sought. We find this can be a problem in practice particularly when the Bidco, acquisition vehicle, is incorporated late in the process. The Supreme Court in Airtours [2016] UK SC 21 held that the recipient of a service must be party to the contract, to receive the services, not just for the purposes of payment and this must accord with economic and commercial reality.
HMRC’s guidance confirms that the holding company must have contracted for the services, including by means of novation. The case of Tesco Freetime [2019] ULUT 18, a reward case, identifies who can be the recipient of a supply, in a tripartite situation. Interestingly, HMRC’s guidance refers to the target subsidiaries themselves being the recipient of services relating to vendor due diligence costs acquired for the purposes of their business, which suggests that certain costs relating to the due diligence process of an acquisition may be capable of recharge to the targets, if such costs further their business.
Direct and immediate link between costs and holding company’s taxable supplies
The third criterion is that the costs must be ‘directly and immediately linked’ to the holding company’s taxable economic activity. This test can also be described in terms of the costs being ‘cost components’ of the holding company’s taxable economic activity.
This question can often give rise to the most uncertainty, and it has been the subject of many CJEU references. The test must be satisfied at the time the costs are incurred, and at that time there must be a genuine intention to make the attributable taxable supplies, even if it turns out those supplies are not made (Ryan Air (Case C-249/17)). The holding company in BAA [2013] EWCA Civ 112 failed because at the time the VAT was incurred, there was no intention to join the VAT group which would make the taxable supplies. Accordingly, it is critical to have a strategy for VAT recovery, before the costs are incurred. HMRC used to insist that the costs incurred should be proportionate to the attributable outputs in amount and be recouped over a five to ten year period, but the CJEU has rejected this and HMRC now simply says the outputs must be genuine and for more than nominal consideration. To be cost components, the costs must be incorporated into the output charges made by the holding company (SKF (Case C-29/08)); however, that can be satisfied where a particular input is linked to a particular output, or where the costs are part of the general overheards, and as such, components of the prices of the goods and services supplied, and linked to the holding company’s economic activities as a whole (Larentia + Minerva ) and University of Cambridge (Case C-316/18).
The direct link to a taxable economic activity can be broken, if the primary use of the expenditure is an exempt supply. This happened in the case of BLP Group Plc (Case C-4/94), where the holding company incurred VAT on fees which led to the sale of subsidiary. This constituted an exempt supply, and it did not help that the purpose of the sale was to raise funds to repay debts. In contrast to an intervening exempt supply, it used to be settled that an immediate nonbusiness activity such as a transfer of a going concern ( Abbey National (Case C-408/98)) or a share issue ( Kretztechnik (Case C-465/06)) did not ‘break the link’. More recently, however, the CJEU has seen no distinction between intervening exempt supplies and non-business activities in this context (see SKF , and the advocate-general’s opinion in Sveda (Case C-126/14), and most recently in the University of Cambridge case.
HMRC, in its VAT Input Tax Manual at VIT40600, helpfully states that a direct link can arise between costs incurred and the holding company’s economic activities generally where the VAT is incurred on costs to secure a ‘direct permanent and necessary’ extension of the holding company’s economic activity (Régie Dauphinoise (Case C-306/94)). In these cases, whether or not the holding company also supplies management services is irrelevant to the input tax recovery. This is the view which Advocate-General Kokott took in Ryan Air , where she considered that the costs were incurred with a view to the expansion of the airline by taking over Aer Lingus, although the CJEU did not decide the case on this ground. Examples in the VAT manual of this principle applying are where a retail company incurs costs buying a subsidiary which owns a property with a view to making retail supplies from the property and where a company incurs costs buying a direct competitor, to increase market share, and achieve economies of scale.
Another interesting but more uncertain argument for establishing a direct and immediate link is that the underlying purpose for incurring the costs can on an objective economic analysis, in itself link those costs to a taxable economic activity. In BLP , the fact that the subjective intention was to raise funds for the general business was held irrelevant: the sale of the subsidiary was a link-breaking exempt supply, but other cases suggest that (what the writer calls) an ‘objective financial purpose’ may sometimes successfully establish a direct link to a taxable activity and therefore a direct link. It often comes down to a matter of impression for the court based on all the circumstances. In Heating Plumbing Supplies [2016] UKFTT 753, a management buyout involved the incorporation of a new holding company and a reorganisation, giving staff the opportunity to subscribe for shares. Half the staff did, and the taxpayer successfully argued that the costs incurred by the holding company furthered the taxpayer’s business by motivating staff. One can conclude that even if no staff had taken up the offer, the holding company would still have had that intention when it incurred the VAT, and the VAT recovery position would have been the same.
The success in Heating Plumbing Supplies is consistent with AG Kokott’s opinion in Ryan Air (discussed above). But in C&D Foods Acquisition ApS (Case C-502/17), a similar argument appeared to work against the taxpayer. Here, the holding company had rendered taxable management services to a sub-subsidiary and had incurred input VAT on costs, with a view to a share sale to raise funds to pay off the bank. No buyer was found and the deal was aborted. The taxpayer argued unsuccessfully that there was a direct link between the costs and the company’s taxable economic activity. The CJEU rejected the link to the management services, and it looked at the taxpayer’s ‘exclusive reason’ for incurring the expenditure. The court decided that this was to repay the bank an activity which did not generate any taxable supplies.
This area of argument raises fascinating possibilities, but it seems to be ultimately a matter of impression based on all the circumstances. In the University of Cambridge case, the university incurred management costs in connection with running its endowment fund, a non-economic activity, but 6% of the income from the fund subsidised the university’s business activities, some of which were taxable. The question arose as to whether there was a sufficient link between the costs incurred in managing the fund, and the other activities to justify treating the costs of managing the fund as general overhead expenditure of the university. The CJEU rejected the argument, maintaining that for the VAT to be deductible the costs must be incorporated into the price of taxable transactions or into the price of goods and services provided by the taxable person in the course of that economic activity. On the facts the costs incurred reduced the price of the good and services provided by the university, and therefore could not be considered cost components of those prices. The CJEU accordingly rejected the argument that a direct link existed to taxable transactions. The CJEU also rejected the concept that subjective intention into why donations were made could have any impact on input tax recovery. The CJEU has, however, in the writer’s view, left open the door to the argument that if the University of Cambridge had added the costs of managing the endowment fund to its other supplies of goods and services, there may be a direct link, applying the ‘objective financial purpose’ argument.
Turning to VAT grouping, a passive holding company applying to register as part of a VAT group with fully taxable trading companies, is not a panacea for VAT recovery. HMRC follow the line taken by the CJEU in Commission v Ireland (Case C-85/11), where the court accepted the advocate general’s opinion, that ‘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.’ In short, HMRC looks for the holding company within the VAT group to make taxable supplies outside the VAT group, or to make loans to other VAT group members, or render other supplies to other members of the VAT group, which are thereby enabled to make taxable supplies outside the VAT group. It is necessary to perform this ‘tracing’ exercise (i.e. tracing through the costs incurred by the holding company to supplies made outside the group), so that the VAT treated as incurred by the representative member of the VAT group can be objectively linked to supplies made outside the VAT group. Also, it should be noted, that on an acquisition, the holding company should not delay before joining the VAT group, so it can be shown that at the time the VAT is incurred, there is an objective link to the VAT group’s supplies (BAA [2013] EWCA Civ 112).
Conclusion
In summary, there are a number of tips for those dealing with this area:
Much is written on VAT and holding companies partly because of the plethora of cases, and partly because, for the tax practitioner, the area brings out some important principles, relevant not only to holding companies, but to input VAT recovery generally.
Also, for groups striving for efficiency and cost saving measures in this age of austerity, all efforts must be made to recover VAT on costs, to the greatest extent possible.
This area of VAT law is unlikely to become settled soon because it is so fact sensitive and applying the legal tests is not straightforward. This article aims to update the reader on recent developments and offers some practical strategies on recovery.
Criteria for recovery
There are three questions which must be answered affirmatively for a holding company to cover VAT on its costs:
Taxable person carrying on an economic activity
On the first question, Polysar (Case C-60/90) decided that the acquisition and holding of shares as an investment activity was not an economic activity. Receiving dividends and making capital gains, merely results from ownership, Larentia + Minerva (Cases C-108 and C-109/14). In contrast, holding shares for the short term, to trade, is an exempt business activity (article 135(1)(f) of the Principal VAT Directive). It should be noted that where the share sale is to a non-EU recipient, the supply is exempt with input VAT recovery, in accordance with the VAT (Input Tax) (Specified Supplies) Order, SI 1999/312, subject to satisfying the use test in reg 103 of the VAT Regulations, SI 1995/2518.
Management services as an economic activity
A holding company will however be involved in a taxable economic activity if it has direct or indirect involvement in the management of its subsidiaries for a consideration (Cibo Participations SA (Case C-16/00) and Floridienne (Case C-142/99)). An economic activity involves not only supplying services for a consideration but also for the purposes of obtaining income on a regular basis (PVD article 9(1); Wakefield [2018] EWCA Civ 952). Management is very widely defined, and includes any transaction subject to VAT, including administrative, accounting or information technology services, even including the leasing of property to a subsidiary (Marle Participations Sarl (Case C-320/17)).
It is important to have management agreements in place, so there is objective evidence, documenting the actual services to be provided by the holding company, and the consideration for those services. That consideration should be calculated on a proper basis, invoiced and paid by the holding company, and the services of course must be genuinely carried out. Norseman Gold [2016] UKUT 69, followed by W Resources Plc [2018] UKFTT 746, held that a vague intention to levy unspecified charges, at some undefined time, when the subsidiaries can afford it, is not sufficient to constitute supplies for consideration. Further, the CJEU in MVM (Case C-28/16) held that not levying intra-group management charges, in the knowledge that there would be dividends and an increase in the value of the corporate group resulting from good management by the holding company, was insufficient to constitute a taxable activity.
Dividends are outside the scope of VAT, and HMRC now accepts that their receipt does not restrict VAT recovery if taxable management services are being provided. It is essential that following a corporate acquisition, management services are rendered by the holding company to all the relevant subsidiaries; if some subsidiaries are not receiving taxable services, the VAT on the costs of acquiring the subsidiaries will be restricted, as held in Larentia + Minerva, which led to the change in HMRC policy.
Holding company as recipient of supply
The second criterion is that the holding company must be the recipient of the supplies on which the input VAT recovery is sought. We find this can be a problem in practice particularly when the Bidco, acquisition vehicle, is incorporated late in the process. The Supreme Court in Airtours [2016] UK SC 21 held that the recipient of a service must be party to the contract, to receive the services, not just for the purposes of payment and this must accord with economic and commercial reality.
HMRC’s guidance confirms that the holding company must have contracted for the services, including by means of novation. The case of Tesco Freetime [2019] ULUT 18, a reward case, identifies who can be the recipient of a supply, in a tripartite situation. Interestingly, HMRC’s guidance refers to the target subsidiaries themselves being the recipient of services relating to vendor due diligence costs acquired for the purposes of their business, which suggests that certain costs relating to the due diligence process of an acquisition may be capable of recharge to the targets, if such costs further their business.
Direct and immediate link between costs and holding company’s taxable supplies
The third criterion is that the costs must be ‘directly and immediately linked’ to the holding company’s taxable economic activity. This test can also be described in terms of the costs being ‘cost components’ of the holding company’s taxable economic activity.
This question can often give rise to the most uncertainty, and it has been the subject of many CJEU references. The test must be satisfied at the time the costs are incurred, and at that time there must be a genuine intention to make the attributable taxable supplies, even if it turns out those supplies are not made (Ryan Air (Case C-249/17)). The holding company in BAA [2013] EWCA Civ 112 failed because at the time the VAT was incurred, there was no intention to join the VAT group which would make the taxable supplies. Accordingly, it is critical to have a strategy for VAT recovery, before the costs are incurred. HMRC used to insist that the costs incurred should be proportionate to the attributable outputs in amount and be recouped over a five to ten year period, but the CJEU has rejected this and HMRC now simply says the outputs must be genuine and for more than nominal consideration. To be cost components, the costs must be incorporated into the output charges made by the holding company (SKF (Case C-29/08)); however, that can be satisfied where a particular input is linked to a particular output, or where the costs are part of the general overheards, and as such, components of the prices of the goods and services supplied, and linked to the holding company’s economic activities as a whole (Larentia + Minerva ) and University of Cambridge (Case C-316/18).
The direct link to a taxable economic activity can be broken, if the primary use of the expenditure is an exempt supply. This happened in the case of BLP Group Plc (Case C-4/94), where the holding company incurred VAT on fees which led to the sale of subsidiary. This constituted an exempt supply, and it did not help that the purpose of the sale was to raise funds to repay debts. In contrast to an intervening exempt supply, it used to be settled that an immediate nonbusiness activity such as a transfer of a going concern ( Abbey National (Case C-408/98)) or a share issue ( Kretztechnik (Case C-465/06)) did not ‘break the link’. More recently, however, the CJEU has seen no distinction between intervening exempt supplies and non-business activities in this context (see SKF , and the advocate-general’s opinion in Sveda (Case C-126/14), and most recently in the University of Cambridge case.
HMRC, in its VAT Input Tax Manual at VIT40600, helpfully states that a direct link can arise between costs incurred and the holding company’s economic activities generally where the VAT is incurred on costs to secure a ‘direct permanent and necessary’ extension of the holding company’s economic activity (Régie Dauphinoise (Case C-306/94)). In these cases, whether or not the holding company also supplies management services is irrelevant to the input tax recovery. This is the view which Advocate-General Kokott took in Ryan Air , where she considered that the costs were incurred with a view to the expansion of the airline by taking over Aer Lingus, although the CJEU did not decide the case on this ground. Examples in the VAT manual of this principle applying are where a retail company incurs costs buying a subsidiary which owns a property with a view to making retail supplies from the property and where a company incurs costs buying a direct competitor, to increase market share, and achieve economies of scale.
Another interesting but more uncertain argument for establishing a direct and immediate link is that the underlying purpose for incurring the costs can on an objective economic analysis, in itself link those costs to a taxable economic activity. In BLP , the fact that the subjective intention was to raise funds for the general business was held irrelevant: the sale of the subsidiary was a link-breaking exempt supply, but other cases suggest that (what the writer calls) an ‘objective financial purpose’ may sometimes successfully establish a direct link to a taxable activity and therefore a direct link. It often comes down to a matter of impression for the court based on all the circumstances. In Heating Plumbing Supplies [2016] UKFTT 753, a management buyout involved the incorporation of a new holding company and a reorganisation, giving staff the opportunity to subscribe for shares. Half the staff did, and the taxpayer successfully argued that the costs incurred by the holding company furthered the taxpayer’s business by motivating staff. One can conclude that even if no staff had taken up the offer, the holding company would still have had that intention when it incurred the VAT, and the VAT recovery position would have been the same.
The success in Heating Plumbing Supplies is consistent with AG Kokott’s opinion in Ryan Air (discussed above). But in C&D Foods Acquisition ApS (Case C-502/17), a similar argument appeared to work against the taxpayer. Here, the holding company had rendered taxable management services to a sub-subsidiary and had incurred input VAT on costs, with a view to a share sale to raise funds to pay off the bank. No buyer was found and the deal was aborted. The taxpayer argued unsuccessfully that there was a direct link between the costs and the company’s taxable economic activity. The CJEU rejected the link to the management services, and it looked at the taxpayer’s ‘exclusive reason’ for incurring the expenditure. The court decided that this was to repay the bank an activity which did not generate any taxable supplies.
This area of argument raises fascinating possibilities, but it seems to be ultimately a matter of impression based on all the circumstances. In the University of Cambridge case, the university incurred management costs in connection with running its endowment fund, a non-economic activity, but 6% of the income from the fund subsidised the university’s business activities, some of which were taxable. The question arose as to whether there was a sufficient link between the costs incurred in managing the fund, and the other activities to justify treating the costs of managing the fund as general overhead expenditure of the university. The CJEU rejected the argument, maintaining that for the VAT to be deductible the costs must be incorporated into the price of taxable transactions or into the price of goods and services provided by the taxable person in the course of that economic activity. On the facts the costs incurred reduced the price of the good and services provided by the university, and therefore could not be considered cost components of those prices. The CJEU accordingly rejected the argument that a direct link existed to taxable transactions. The CJEU also rejected the concept that subjective intention into why donations were made could have any impact on input tax recovery. The CJEU has, however, in the writer’s view, left open the door to the argument that if the University of Cambridge had added the costs of managing the endowment fund to its other supplies of goods and services, there may be a direct link, applying the ‘objective financial purpose’ argument.
Turning to VAT grouping, a passive holding company applying to register as part of a VAT group with fully taxable trading companies, is not a panacea for VAT recovery. HMRC follow the line taken by the CJEU in Commission v Ireland (Case C-85/11), where the court accepted the advocate general’s opinion, that ‘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.’ In short, HMRC looks for the holding company within the VAT group to make taxable supplies outside the VAT group, or to make loans to other VAT group members, or render other supplies to other members of the VAT group, which are thereby enabled to make taxable supplies outside the VAT group. It is necessary to perform this ‘tracing’ exercise (i.e. tracing through the costs incurred by the holding company to supplies made outside the group), so that the VAT treated as incurred by the representative member of the VAT group can be objectively linked to supplies made outside the VAT group. Also, it should be noted, that on an acquisition, the holding company should not delay before joining the VAT group, so it can be shown that at the time the VAT is incurred, there is an objective link to the VAT group’s supplies (BAA [2013] EWCA Civ 112).
Conclusion
In summary, there are a number of tips for those dealing with this area:
