BAA appeal against denial of input VAT recovery on bid costs dismissed (Court of Appeal)

Practical Law UK Legal Update 4-524-3628 (Approx. 8 pages)

BAA appeal against denial of input VAT recovery on bid costs dismissed (Court of Appeal)

by PLC Tax

Background

VAT is charged on certain supplies made by a taxable person. A taxable person may recover input tax (by deduction or repayment) on supplies of goods or services that it receives to the extent that the person uses (or intends to use) those goods or services in making taxable supplies.

(For a general discussion of the UK VAT rules, see Practice note, Value added tax.)

Input tax recovery

The ECJ has ruled that input tax recovery is only permitted where one of the following applies:

There is a direct and immediate link between a particular input transaction and a particular taxable output transaction (Commissioners of Customs and Excise v Midland Bank plc (Case C-98/98), Abbey National (C-408/98) and BLP Group plc v Commissioners of Customs & Excise (C-4/94)).
The costs in relation to which the input tax arises are part of the taxable person's general overheads and form a component of the price of goods or services provided by that person. Such costs have a direct and immediate link with the taxable person's economic activity as a whole (Midland Bank and Kretztechnik AG v Finanzamt Linz (C-465/03)).
In Cibo Participations SA v Directeur Regional des Imputs du Nord-Pas-de-Calais (Case C-16/00), the ECJ held that expenditure incurred by a company in relation to services that it obtained in connection with acquiring a subsidiary forms part of its general costs so that it has, in principle, a direct and immediate link with the holding company's economic activity as a whole.

In addition, in order to recover input tax, a taxable person must carry on a business (to use the UK term) or an economic activity (to use the EU term) (see Practice note, Value added tax: Business purpose). The ECJ has held that the mere acquisition and holding of shares is not an economic activity (Kretztechnik). In Polysar Investments Netherlands BV v Inspecteur der Invoerrechten en Accijnzen (Case C-60/90), the ECJ held that this does not apply if the holding is accompanied by direct or indirect involvement in the management of the subsidiary. Among the activities that may fall within the scope of such involvement are the carrying out of taxable transactions, such as administrative and accounting services, and making capital available to the subsidiary (Floridienne SA v Belgian State (Case C-142/99)). However, there can be no economic activity without taxable supplies (or at least an intention to make taxable supplies) (Cibo).

(For further details of the UK VAT treatment of holding companies, see Practice note, Holding companies: VAT.)

The right to recover input tax arises when the input tax becomes chargeable (see Practice note, Value added tax: Person to whom supply is made).

Attribution of taxable supplies to other entities

The case of Finanzamt Offenbach am Main-Land v Faxworld Vorgründungsgesellschaft Peter Hünninghausen und Wolfgang Klein GbR (Case C-137/02) concerned a German partnership that was established with the sole object of setting up a company, to which the business and assets of the partnership would be transferred. The transfer, under the German transfer of going concern rules, was not a supply for German VAT purposes. In Faxworld, the partnership incurred VAT on certain preliminary transactions resulting in assets that were transferred to the company. The partnership never made (or intended to make) taxable supplies itself. The partnership sought to recover its input tax. The ECJ held that as the company made taxable supplies and was the successor to the partnership, the partnership was entitled to take account of the company's taxable supplies. The partnership was, therefore, entitled to recovery of input tax because the supplies to the partnership were procured for the purposes of the company's taxable operations.

VAT grouping

The UK allows members of a corporate group to elect to be treated as a single entity for VAT purposes. For details of the UK's VAT grouping rules, see Practice note, Value added tax: Group registration. Accordingly, the representative member of the group is treated as if it were carrying on the businesses of all of the members of the group (treating supplies to, and by, members of the group as supplies to, and by, the representative member).

Facts

In spring 2006, an investment consortium led by Ferrovial, a Spanish group, launched a successful takeover bid for BAA plc (BAA), a UK airport operator. The acquisition was made by a vehicle company, Airport Development and Investments Limited (ADIL), which was set up for the takeover. The first bid by ADIL was rejected by BAA but ADIL's revised bid was recommended by the board of BAA. BAA became a wholly-owned subsidiary of ADIL on 26 June 2006 (completion).

ADIL incurred significant fees for services provided by a bank and professional advisers. The bank provided ADIL with debt financing, comprising two facilities granted at the time ADIL declared its intention to make an offer for BAA. The first of the facilities was expressed to be available, among other things, to finance ADIL's acquisition of BAA and/or to finance a refinancing of the indebtedness of a BAA group member. The other facility was expressed to be available, among other things, to fund capital expenditure by members of the BAA group. The documentation engaging the bank showed that ADIL intended to refinance its own indebtedness and that of the BAA group within two years of the acquisition. The refinancing was effected in July 2008.

In September 2006, ADIL applied to HMRC to join the BAA VAT group. HMRC accepted ADIL's application on 22 September 2006. ADIL supplied administrative and management services to existing group members but no charges for those supplies were ever raised.

The representative member of the BAA VAT group reclaimed the VAT suffered by ADIL as input tax of the group, attributable to the group's general overheads. HMRC disputed this claim on the basis that the costs incurred by ADIL related to the acquisition and were, therefore, investment costs with no direct and immediate link with any taxable supplies (to be) made by the BAA group. HMRC therefore raised a VAT assessment against the BAA group of approximately £6.7 million. BAA Ltd (BAAL) the representative member of the BAA VAT group, appealed to the Tax Chamber of the First-tier Tribunal (tribunal).

First-tier Tribunal decision

The tribunal allowed BAAL's appeal and held that it was entitled to reclaim the input VAT.

The tribunal made the following key findings of fact:

ADIL was formed as a bid vehicle for the take-over of BAA and for the purpose of providing high-level strategic governance of the BAA group, incurring the fees in connection with the BAA acquisition.
The take-over was not as an end in itself but a first, necessary step towards long term, large investment in UK airport infrastructure.
ADIL assumed direction and leadership of the BAA group, taking over its strategic governance as a long term business undertaking; it was an active management company.
There was a single overall transaction as a means to an end, the business plan covering both the acquisition and subsequent management developments.
From completion, it was expected that ADIL would charge the BAA subsidiaries fees for its services, but none were ever levied.
Before completion, there was no evidence of an intention to make intra-group charges.
There was no evidence that, at the time that it received the supplies, ADIL intended to make taxable supplies.
From completion, it was intended that ADIL should become a member of the BAA group, but there was no evidence of such an intention before completion.

The tribunal concluded that:

But for the fact that ADIL never made taxable supplies, ADIL carried out an economic activity from its incorporation, as there were continuing benefits beyond the acquisition, which was a necessary step in ADIL's larger involvement and long term investment in UK airport infra-structure (rather than the BAA shares acquisition being an end in itself).
Direct or indirect involvement in the management of subsidiaries is an economic activity. However, economic activity required the making of taxable supplies and it was common ground that ADIL never made any. Further, although an intention to make taxable supplies was sufficient, there was no evidence that, at the time ADIL received the services, ADIL had such an intention or an intention to join the BAA VAT group.
The principle established in Faxworld was, however, applicable so that the VAT incurred by ADIL in connection with the economic activity of managing the subsidiaries within the BAA VAT group could be attributed to taxable supplies made by the BAA VAT group and imputed to ADIL, allowing the tribunal to conclude that ADIL carried on an economic activity.
It also followed from Faxworld that there was a direct and immediate link to the general overheads of the representative member of the VAT group.

For details of the decision, see Legal update, Input tax recoverable for share acquisition costs: Decision.

Upper Tribunal decision

On HMRC's appeal to the Upper Tribunal (UT), the UT allowed the appeal ruling that the input tax was not recoverable because, although ADIL was carrying on an economic activity when it incurred the input VAT, there was no direct and immediate link between the input VAT and the BAA VAT group's taxable supplies, rejecting the application of Faxworld. In particular, the UT held that:

When ADIL incurred the input tax, it was carrying on an economic activity, which was apparent from the tribunal's finding that the BAA acquisition was the first step in a long term investment involving the management of, and the provision of services to, the BAA group.
However, there was no direct and immediate link between the input tax and any taxable supplies made by, or imputed to, ADIL. The supplies to ADIL were concerned with the acquisition rather than the services provided by ADIL to the BAA group (any continuing benefit to the group was too remote to provide a "direct and immediate" link). Further, given the tribunal's finding that, before completion, ADIL had no intention to provide taxable services, the input tax could not be attributed to post-completion supplies.
When ADIL incurred the input tax, it was not a member of the BAA VAT group and had not formed an intention to join it. Therefore, the input tax could not be attributed to the post-completion supplies of the BAA VAT group (grouping issue).
Faxworld had no application. In Faxworld, the partnership was established for the express purpose of establishing the company and it incurred the input VAT in connection with that aim. A direct and immediate link between the input tax and the company's taxable supplies was self-evident.

For details of the decision, see Legal update, VAT input tax on bid costs irrecoverable: BAA loses in Upper Tribunal (detailed update).

BAAL appealed against the UT's decision.

Decision

The Court of Appeal dismissed BAAL's appeal holding that ADIL was not carrying on an economic activity at the time the input tax was incurred.

Both the tribunal and the UT were wrong in concluding that ADIL was carrying on an economic activity at the time the input tax was incurred. At that time, ADIL's only intention was to acquire the shares in BAA. While that was an act with economic consequences, it was not carrying on an economic activity for VAT purposes. The tribunal had found no evidence that, at that time, ADIL made, or intended to make, taxable supplies. That finding of fact was fatal to the contention that ADIL was carrying on an economic activity.

While that ruling was enough to dismiss BAAL's appeal, the Court of Appeal also gave its conclusions on the other disputed issues. Although there was a tenuous link between the services supplied to ADIL and the taxable services supplied by BAA, in that it facilitated the acquisition of BAA, which was making taxable supplies, it could not be said that there was a "direct and immediate" link. When ADIL incurred the input tax, the related supplies to ADIL were unconnected with any supply ADIL intended to make and the taxable supplies being made at that time by BAA were not linked with the supplies received by ADIL. Accordingly, the tribunal's finding that there was a direct and immediate link between the input tax on the supplies of services to ADIL and the output tax on the supplies of taxable services made by BAA was wrong.

In relation to the Faxworld and grouping issues, the Court of Appeal agreed with the UT. BAA's taxable supplies could not be imputed to ADIL (so as to provide the direct and immediate link), either through its subsequent membership of the BAA VAT group, or through the application of the Faxworld principle, which allows input tax recovery against supplies made by a successor entity. Faxworld represents a limited departure from the general rule that the input tax of one person may not be treated as a cost component of the supplies of another. Here, BAA was not the successor of ADIL and, therefore, Faxworld had no application.

Comment

It is too early to know whether there will be an appeal to the Supreme Court although, given that the decision was unanimous, it seems unlikely that leave to appeal will be granted. Although BAA lost in the UT, some comfort was taken from the fact that the UT decided that ADIL was carrying on an economic activity, although, the more difficult issue is, perhaps, the extent to which the input tax incurred by acquisition vehicles has a "direct and immediate link" to, or is a "cost component" of, subsequent taxable supplies.

The Court of Appeal regarded the tribunal finding that, at the time ADIL incurred the input tax, it had not made, or formulated an intention to make, taxable supplies as "fatal" to a conclusion that it was carrying on an economic activity. So too the finding that it had not formulated any intention to join the BAA VAT group until after completion. This ruling highlights the importance of considering the issue of VAT recovery at the outset of the takeover (or other acquisition) process (and certainly no later than the time that VAT is incurred) with a view to maximising the chances of input tax recovery. The recent tribunal decision in Cloud Electronics Holdings Limited v HMRC [2012] UKFTT 699 (TC) (see Legal update, VAT input tax recovery for MBO acquisition vehicle allowed (First-tier Tribunal)), also shows that HMRC will challenge input tax recovery on corporate transactions on different bases. The care taken with engagement letters allowed the taxpayers in that case to bat away the argument that the supplies of professional services were not made to the acquisition vehicle.

While there are other input tax recovery corporate transactions cases in the pipeline, which will, no doubt, develop the law in this area further, this case demonstrates the importance of early consideration of VAT in the bidding or acquisition process (albeit that it will not necessarily provide a guarantee of success). It is clear from the Court of Appeal's decision that timing is critical. In particular, the bidder or acquirer should include:

Registering the acquisition vehicle (A) for VAT, which requires demonstrating an intention to make taxable supplies.
Paying careful attention to the preparation of engagement letters, invoices and the like.
Documenting (in board minutes or otherwise) A’s intention (supporting its formulation before completion) to carry out economic activities (that is, provide taxable management services to target) and that it is not a passive investment company.
If relevant, documenting A’s intention to join or establish a VAT group with target immediately following acquisition of target.
If relevant, following completion, immediately apply for VAT group membership (from the date of acquisition) and start providing and charging for management services.

Case

BAA Ltd v HMRC [2013] EWCA Civ 112 (Mummery, Patten and Parker LJJ).

BAA appeal against denial of input VAT recovery on bid costs dismissed (Court of Appeal) | Practical Law