Publish Date
Aug 07, 2023
Industry Insights
The recent Upper Tribunal (UT) decision in the case of The Commissioners For His Majesty’s Revenue And Customs v Hotel La Tour Ltd [2023] UKUT 00178 (TCC) upheld the First-tier Tribunal (FTT) decision in 2021. Both Tribunals’ decisions were in favour of the taxpayer on the core issue of whether the sale of shares by an active holding company, which were demonstrably intended to generate proceeds to reinvest into a taxable business, constituted overhead costs of the business. As a result, the VAT incurred on sell-side costs was recoverable.
In particular, the UT considered whether the costs incurred on Hotel La Tour Ltd (HLT)’s disposal of its subsidiary were directly and immediately linked to an exempt share sale (with no right to recover input VAT); or directly and immediately linked to HLT’s wider taxable business (via the VAT group), on the basis that the shares were sold to raise funds to build a new hotel and make downstream taxable supplies.
The recovery of VAT on transaction costs is a contentious area for VAT and subject to HMRC scrutiny. This case emphasises the benefit of ensuring intentions are well documented in the event that HMRC should challenge the position.
The case will be of interest to other taxable businesses either intending to divest or dispose of a subsidiary company as a capital raising exercise or have already done so within the last 4 years. There is an opportunity here to support VAT recovery in relation to future sales and consider the scope for retrospective claims where VAT has previously been blocked from recovery.
HLT was a holding company and representative member of a VAT group which owned 100% of the share capital of Hotel La Tour Birmingham Ltd (HLTB), a member of the same VAT Group. HLT provided management services to HLTB which in turn operated a luxury hotel in Birmingham. In order to fund the construction of a new hotel in Milton Keynes, alongside a bank loan, HLT decided to sell HLTB.
The sale completed in 2017 and HLT removed HLTB from the VAT group. The development of the Milton Keynes hotel began and the FTT found, as a matter of fact based on the strong evidence provided, that all the proceeds from the sale of HLTB were used towards funding the development/ construction.
However, the issue arose when HLT sought to recover VAT of c.£70K on professional fees incurred in relation to the sale within its September 2017 VAT return. HMRC subsequently challenged the recovery of this input tax and raised a VAT assessment on the basis that the costs had a direct and immediate link to an exempt supply of a sale of shares, rather than looking through the transaction as a means of funding downstream making taxable supplies by the VAT group.
HMRC’s long-standing approach, supported by the Court of Justice of the European Union (CJEU) judgment in BLP Group PLC (C-4/94) (BLP), has been that the sale of shares is exempt for VAT purposes. Consequently, any VAT incurred on costs that can be directly attributed to an exempt supply, is irrecoverable. HMRC’s position, based on the BLP judgment, is that this should not be modified even where the purpose of the sale is to fundraise for a taxable activity. HMRC argued that the services were:
“…purchased in order to maximise the price of the shares; funded by the proceeds of the sale rather than by the profits of any taxable output transaction; and the profits of the sale were used for purposes including paying off HLTB’s loan.”
The FTT agreed that the proceeds of the sale were used to purchase the services but noted that this meant that the amount available for taxable transactions reduced, hence the services were a cost of the taxable transactions.
Nevertheless, HMRC appealed to the UT and contended the FTT had applied the wrong test to determine whether there was a direct and immediate link between the services and the sale of shares.
The FTT explored the case law available, in particular how the CJEU and UK Courts had moved away from the now 28-year-old BLP judgment, and ultimately disagreed with HMRC’s view of the law that the VAT recovery position should not be modified for fundraising transactions, i.e. a look through is possible.
Both the FTT and UT cited the more recent case law which enabled VAT recovery in relation to transactions that were outside the scope of UK VAT, on the basis that the costs constituted general overheads of the taxable business. Overall, the UT recognised that the distinction should not be whether the share sale is exempt or outside the scope of VAT; the concern is, on the basis of evidence provided and facts found by the FTT, the ultimate purpose of the share sale and whether this is to support the wider economic activity of the business.
The downstream taxable activity of HLT (i.e., the construction, development, and management of the Milton Keynes hotel) was never in dispute based on the facts agreed between the parties and found by the FTT and thus, the UT dismissed HMRC’s appeal.
Recovery of VAT on sell-side costs is a contentious area of VAT and may continue to be so. However, the decision of the UT has precedent value and provides an insight into steps to take for best practice, particularly in documenting a sufficient audit trail or defence file.
Currently, the prudent position on recovery of VAT on sell-side costs is that VAT is irrecoverable and costs should be grossed up to include irrecoverable VAT for the purposes of working capital. HMRC guidance does provide an exception in the following statement, however we note this guidance appears inconsistent and does not have force of law:
“The VAT on costs incurred by the target of an acquisition, such as vendor due diligence costs, may also be deductible provided it can be shown that the target is the recipient of the supplies in question and those supplies were received for the purposes of the business carried out by the target.”
Generally, this guidance is used to seek VAT recovery on costs where it can be demonstrated that the services purchased provide an ‘enduring benefit’ to the entity/ entities being sold (the Target), where the Target is receiving and using such services. VAT recovery on costs incurred only for the purpose of the sale, for example data room costs and legal fees in relation to the sale and purchase agreement, is typically blocked in full.
This case provides another option whereby the ability to track the use and intention of the funds/proceeds, to the extent they will be reinvested back into the business, could enhance the VAT recovery position for businesses.
We note that VAT recovery on transaction costs is, and will continue to be, an area subject to challenge by tax authorities in the UK and EU and case law. Only last month, the Dutch Court ruled that private equity investment funds are not entitled to recover VAT on such costs.
Whilst this particular case of HLT may not be relevant to private equity funds in the UK, on the basis that this was corporate acquisition, it is important to understand the guidance and case law available in this area, to ensure VAT leakage is minimised. To the extent that certain actions are taken in a timely manner, and sufficient documentary evidence is obtained at relevant stages, VAT recovery on at least a portion of sell-side costs may be achievable for taxable businesses.
The A&M Indirect Tax team has a wealth of experience in this area to support businesses in getting everything in place and present a sufficient basis for recovery to HMRC.
The outcome of this case could have a significant impact for corporate clients involved in the divesting of entities in the corporate group by way of selling of shares to fund the wider business activity. The fact pattern appears to be one that can capture a wide range of businesses that could benefit from increased VAT recovery, therefore raising increased capital to reinvest as intended.
We see this opportunity applying not only to businesses considering prospective restructuring, divesting or disposing of companies to raise funds in the future, but also retrospectively by reviewing the VAT recovery position on historic transactions.
To the extent sell-side costs have been incurred and recovered within the last 4 years (i.e., the VAT statute of limitations) there is now scope to put in place a defence file to support VAT previously recovered. Alternatively, there may also be scope to submit a claim for VAT that was not previously recovered, and as a result of the principles of case, it may now be possible to do so.
Please contact Mairead Warren de Burca, Mark McKay, or your regular A&M contact, to discuss further.
VIT40600 – When is VAT recoverable by holding companies – HMRC internal manual – GOV.UK (www.gov.uk)
Transaction & Corporate Restructuring – Opportunity for increased VAT recovery on costs
