Tax Talk: Recovery of VAT on deal fees
The VAT rules in relation to acquisitions are complex. We look at the recent Ince Gordon Dadds versus HMRC case to see how companies can be better prepared.
Businesses which make company acquisitions as part of their growth strategy often incur significant costs for due diligence and other professional fees. Recovery of VAT on these costs is not straightforward. In fact, it can lead to significant disputes between businesses and HMRC, sometimes ending in litigation. But there are ways of reducing the chance of an HMRC challenge to the recovery of this VAT. The key is to consider the position at the outset and take appropriate action.
Usually, legislation only permits the recovery of VAT where it is considered to be ‘attributable’ to taxable supplies. For VAT relating to company acquisitions HMRC takes the view that, for such VAT to be claimable, there needs to be a ‘direct and immediate link’ between the VAT costs incurred and the taxable supplies made.
Where a business simply acquires a company and then passively holds the acquired entity without any economic activity of its own, HMRC will usually rule that the VAT incurred on the costs of acquiring subsidiaries are not recoverable. This view will still apply even if the holding company joins a VAT group with the acquired companies.
Ince Gordon Dadds VAT case
The recent First-tier Tribunal (Tax) case of Ince Gordon Dadds LLP (IGD) highlights this issue. The FTT did not accept an appeal made by the company over HMRC’s rejection of its claim for the recovery of VAT. This related to costs incurred by the acquirer Work Group plc (WG) on a fundraise it made for Ince Gordon’s acquisition. Whilst bank or stockbroker charges for fundraising are typically exempt from VAT, WG incurred VAT on related accountancy, advisory and stock exchange fees.
Following acquisition, WG joined a VAT group with IGD and recovered the input VAT costs on the VAT group’s subsequent VAT filing.
HMRC rejected the claim for VAT costs on the fundraise because it didn’t believe there was a sufficient link between the costs incurred and the ongoing taxable activities of the VAT group.
HMRC said WG had not provided sufficient evidence to show it was engaged in economic activity at the relevant time. Whilst WG entered into a management services agreement (MSA) with IGD and other group entities, this did not happen until about two years post acquisition, although the MSA backdated supplies to the takeover date.
Despite the existence of an MSA and associated invoice, HMRC didn’t accept these as proof that WG had its own economic activity in supplying management services in return for payment – that was separate from any dividends received. What’s more, HMRC noted that WG’s accounts showed no services were provided to any of the group entities either at the time of, or after, the takeover.
View of the Tribunal
The Tribunal held that the input VAT costs incurred for the acquisition were not recoverable, and dismissed IGD’s appeal.
It said that the burden of proof is on the claimant to show that the VAT costs are attributable to a taxable business activity. It held that where there are costs in relation to a fundraise for an acquisition, related input VAT is recoverable if the funds are used for a future taxable activity of that entity. In the case of an acquirer joining a VAT group with the acquired entity, this test is applied to the activities of the VAT group as a whole.
Despite this, the Tribunal said it was not persuaded that the MSA and associated invoice, both drawn up long after the event, demonstrated a taxable business activity by WG. It determined that the funds were to be used primarily for WG purchasing and holding new subsidiaries, rather than for the acquired company’s management services. It therefore held that the input VAT was irrecoverable.
What actions can businesses take?
This ruling shows that an acquirer joining a VAT group with the acquired entity following an acquisition doesn’t necessarily demonstrate the necessary link with the VAT costs incurred and future taxable supplies.
The decision highlights the importance of proving that the acquirer will be undertaking taxable economic activities post acquisition, and ideally showing this intention at the outset. Entering into an MSA between the acquirer and acquiree at the time of the acquisition can help to demonstrate this. If an MSA is drawn up at a later date, and/or if the corresponding charges under the MSA are not made, this makes it more difficult to establish the link between the VAT costs on the acquisition and the subsequent taxable management services.
It’s important to consider each case on its own merits to see whether a business is able to recover the VAT incurred on transactional fees and the related VAT implications.
If you would like advice and support on any issues raised in this article, please contact Nadav Shayovitz.