Capital Quarter: VAT: how hard can it be? (Quite hard, it turns out)
Trying to recover VAT incurred on legal and professional fees? If you want to steer clear of the courts, act early and seek professional advice.
Refunds of VAT on expenditure incurred by holding companies is a complex and frequently litigated area of VAT law. The amount of VAT at stake is often significant.
Many businesses don’t give it the consideration it deserves before incurring the VAT-bearing expenditure. Nor do they act decisively enough to seek a refund from HMRC. They either don’t consider themselves able to obtain a refund of the VAT or have tried to do so but then had HMRC reject their VAT refund claim(s). This sometimes leads to penalties and costly, uncertain litigation stretching over several years.
HMRC’s position has been clearly set out in its published guidance since 2017. It is that it should accept that holding companies are trading for VAT purposes provided there is documentary evidence to support that assertion. Examples are set out in the guidance.
When holding companies are trying to recover VAT incurred on their legal and professional fees, one of the most common types of trade for VAT purposes that they carry on is the supply of management services. But difficulties arise where a holding company raising equity does not yet have any subsidiary companies. This might be because it intends to acquire one or more subsidiaries in future using the equity raised. In this case, the holding company needs to prove its intention to make such management service charges in future. Not only must HMRC be satisfied, but potentially also the courts.
The Ferrovial case
The most famous court case on this point relates to the recovery of VAT incurred on legal and professional fees by Ferrovial during its takeover of BAA. The Court of Appeal denied the recovery of VAT. Why? Because at the time that Ferrovial’s acquisition vehicle (Airport Development and Investments Ltd, ADIL) incurred the legal and professional fees for the takeover, it couldn’t prove that it intended to supply VAT-able management services to BAA in the future if the takeover was successful.
This case illustrates our point. Had Ferrovial consulted VAT advisers before the legal and professional fees were incurred, they would likely have referred the company to HMRC’s published guidance on supporting documentation. It offers a lengthy list of examples that intending traders (such as ADIL) might produce in order to prove to HMRC their intention to make VAT-able supplies at some point in the future. If ADIL had provided such documentary evidence before incurring the fees relating to the takeover, it might have been able to reclaim £6.7million of VAT.
The issue with free supplies
Difficulties also arise where a holding company’s current subsidiaries are not yet making sales or profits. That means they aren’t in a position to absorb more costs for management service charges from their holding company. Many UK listed holding companies of non-UK subsidiaries have been challenged by HMRC because it didn’t believe they were actually receiving ‘consideration’ (as defined for VAT purposes) from their subsidiaries, and so were supplying their management services to them free-of-charge.
As free supplies of services are not a VAT-able activity, the holding companies could not (in HMRC’s view) reclaim the VAT incurred on their legal and professional fees. There have been several recent court cases with this focus. The resulting body of case law means there’s now more certainty as to what HMRC and the courts will accept as evidence that the subsidiaries are paying consideration to their holding companies. This enables their holding companies to be registered for UK VAT and to reclaim VAT on their legal and professional fees.
So what are the key messages from all this?
- Just because VAT has always been a self-assessed tax does not mean that it isn’t complex and open to interpretation. To help with that complexity, there are many VAT advisers in the UK who are a member of the Chartered Institute of Tax.
- It is always worth consulting a VAT specialist before incurring legal and professional fees in order to gain greater certainty and better recovery of VAT.
It is best to act on the recommendations from the VAT specialist as soon as possible because there is now a body of detailed HMRC guidance and VAT case law to support those recommendations.
For further guidance on VAT, please contact Mark Ellis.