UK VAT: how to keep your natural resources company ahead of HMRC
Read time: 5 mins
It’s easier than you think to fall foul of the complicated VAT rules for holding companies. We help you steer through the obstacles.
Many natural resources groups set up a company in the UK that issues shares to subscribers, for example on AIM. These companies then incur significant UK VAT on associated legal and professional fees, not only related to the initial fundraising but also on future costs (such as audit fees).
HMRC can challenge the recovery of such UK VAT on expenditure on the basis that the company does not have a UK fixed establishment (for UK VAT purposes) and / or it is not making (or cannot show to HMRC’s satisfaction its intention to make) ‘taxable supplies’ for UK VAT purposes.
To prevent UK VAT becoming an additional cost, many UK group holding companies apply to HMRC to register for UK VAT. This means they can file UK VAT return forms, on which they try to reclaim from HMRC the VAT incurred on expenses. HMRC can raise queries when it receives the VAT registration application or when it receives the first VAT return seeking a refund of VAT. But it often doesn’t do so at this stage. As a result, the holding companies believe HMRC agrees that they are entitled to be registered for VAT and can reclaim UK VAT incurred on expenses.
Beware of retrospective reviews
But case law precedent shows that just because HMRC hasn’t challenged the content of a form, it doesn’t mean there is implicit agreement.
So, many UK holding companies of natural resources groups find themselves in a precarious position when HMRC carries out a review of VAT returns filed in the past four years and are told that, not only are they not entitled to receive UK VAT refunds relating to their expenditure, but they should not even be UK VAT-registered at all.
HMRC then issues assessments clawing back the VAT refunds made in the past four years. It also charges interest (currently 7.75% per annum) and potentially a ‘careless error’ penalty of 15-30% of the value of the VAT clawback assessments. Penalties may seem harsh. But HMRC’s view is that the CFO of a natural resources group’s UK holding company cannot argue that they’ve taken ‘reasonable care’ with the company’s UK VAT accounting, when HMRC’s website clearly explains the main EU / UK case law precedent relating to the recovery of VAT incurred by holding companies. Many of those cases involve holding companies of natural resources groups. HMRC also gives guidance on the route they should follow to recover VAT on expenditure.
Route to success
Firstly, the UK holding company must either belong in the UK or have a UK fixed establishment for VAT purposes. Merely being incorporated in the UK and having a UK registered office is not enough for VAT purposes. It needs one or more of the following:
- a UK office
- UK-resident employees and / or UK-resident self-employed contractors
- UK-resident directors
- in-person board meetings in the UK.
There is good news. If a UK holding company isn’t eligible to be UK VAT-registered on the criteria above, not only should it not be UK VAT-registered but neither should the UK suppliers of legal and professional services to the company have charged UK VAT on those services.
If VAT has been incorrectly charged, companies should seek refunds from their suppliers in respect of historic services, and check that no VAT is charged in future (unless or until the holding company does establish some kind of UK presence for VAT purposes.
Tax supplies matter
Secondly, the UK holding company must have an intention to make ‘taxable supplies’ in the future. For VAT purposes, taxable supplies include:
- loan interest charged to overseas subsidiaries, and paid for (in cash or with shares)
- loan interest charged to UK subsidiaries, where those subsidiaries are members of the same VAT group registration as the holding company, and paid for (in cash or with shares)
- management / support services supplied to subsidiaries, whether they are in the UK or overseas and where they are members of the same VAT group registration as the holding company, and paid for.
Unfortunately, an intention to receive future share dividends from subsidiaries is not enough. This is because share dividends are not (for VAT purposes) consideration paid in return for services supplied by the shareholders.
For further information, visit our related articles on the wider consequences (and potential benefits) of making such downstream supplies, and the requirements for these to be priced correctly for transfer pricing purposes.
Providing future intentions
Unsurprisingly, HMRC is sceptical of tales from holding company CFOs attempting to defend against UK VAT assessments. Backed up by VAT case law precedent in its favour, HMRC expects to see documented evidence of the holding company’s intention to make ‘taxable supplies’ in the future. These documents typically include one or more of:
- board meeting minutes
- initial share offer prospectus
- financial accounts
- draft / final agreements for interest-bearing loans, management services and support services.
Evidence of supplies
When services are supplied, HMRC expects to see payments being made or received. This is because payment is a requirement for a service to take place for VAT purposes. Ideally, payments will involve cash movements from the subsidiaries’ bank accounts into the UK holding company’s bank account. Where this isn’t possible, intercompany account entries may be accepted, so long as they actually discharge the debt owed to the holding company and are not merely an indication that the money is owed and needs to be paid in due course.
Interaction with Corporation Tax
The challenge is to ensure that loan interest and service fees charged by holding companies to their subsidiaries do not create withholding tax or transfer pricing issues. So, it’s best to adopt a holistic approach by considering all the taxes at the outset, ideally before the initial share issue to raise funds for the holding company.
Too often, we find ourselves fighting a rear-guard defensive action after HMRC VAT assessments are issued, or while the annual audit is going on. This is unfortunate because tax specialists understand the route to success. So the holding company CFOs just need to access that knowledge as early as possible to avoid future problems.
For more guidance on VAT for natural resources companies, please contact Mark Ellis.