For well over a decade, the recovery of VAT by holding companies and VAT on transaction costs has been a continued area of uncertainty, with a multitude of case-law decisions making it difficult for businesses to know for sure when they can and cannot reclaim VAT.
Some recent high profile cases at the Supreme Court and the European Courts of Justice should now start to clarify the areas of uncertainty and inform the strategy that businesses should adopt.
In brief, what is HMRC’s policy?
In essence, HMRC says that any VAT costs which are attributable to a passive shareholding activity will not be recoverable as they relate to non-economic activities. This extends to holding companies that merely carry out this non-economic activity whilst members of a fully taxable VAT group, with HMRC highlighting that the holding company can no longer rely on the taxable outputs made by the VAT group to recover their own costs.
Full or partial VAT recovery of costs may be available where the holding company is engaged in taxable economic activities and the costs are cost components of, and have a direct and immediate link with, the taxable economic activities. Costs are components of the price of a taxable supply if they support the making of that supply and it is intended, at the time the costs are incurred, that the expenditure will be recouped from the income resulting from that supply.
Previously, HMRC required the price charged by businesses to be set at a level which recoups the transaction costs over a period of five to ten years, this requirement is not present in their new guidance.
The strategy that businesses adopt will need to be decided on a case by case basis and ideally at the beginning of transactions when engagement letters are in draft. Any steps taken should be given in the context of what is commercially and practically possible for that specific business.
In each case it is important to consider the VAT strategy in conjunction with considering whether a corporate tax deduction is possible, the transfer pricing methodology and documentation together with the legal and commercial aspects.
A key VAT requirement is the substance contained in Holdco to allow it to be able to provide management services. For example, what staff can it employ, do those individuals have the necessary experience to provide services, what is the nature of the services and what is the charging structure?
Do not forget that the first step is for businesses to consider whether their suppliers are right to charge them VAT, as some activities can qualify for an exemption.
Finally, irrespective of where the case-law and guidance finally ends up, there will always be some costs for which VAT recovery is not possible, for example, VAT incurred on third party legal fees.
This article was written by Robert Marchant, Head of Corporate VAT at Crowe Clark Whitehill LLP.