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VAT input tax on bid costs irrecoverable: BAA loses in Upper Tribunal (detailed update)
Practical Law UK Legal Update 7-506-6558 (Approx. 6 pages)
VAT input tax on bid costs irrecoverable: BAA loses in Upper Tribunal (detailed update)
by PLC Tax
| Published on 28 Jun 2011 |
In a decision released on 22 June 2011, the Upper Tribunal allowed HMRC's appeal against the recovery of input VAT on professional fees related to the acquistion of another company. (HMRC v BAA Limited [2011] UKUT 258 (TCC) (22 June 2011).) (Free access.)
Speedread
In a judgment released on 22 June 2011, the Upper Tribunal (UT) allowed HMRC's appeal in HMRC v BAA Limited and held that VAT input tax on professional fees incurred by a bidding company in the course of a takeover of a target company (BAA) was irrecoverable. The UT held that, although the bidder could be said to have acquired the shares in the course of an economic activity, there were no onward taxable supplies made by the bidder (or attributed to the bidder under the VAT grouping rules), at the time the bidder incurred the relevant input tax, to which the professional services had a direct and immediate link. The UT therefore reversed the decision of the First-tier Tribunal and disallowed recovery of the input tax.
The decision, although perhaps not entirely unexpected, will be disappointing for bidders involved in significant takeovers in similar circumstances. It also appears to limit, if not exclude, the entitlement of the bidder to claim the input VAT on the professional fees associated with acquisition against taxable supplies of management services that it subsequently makes to the acquired companies. (HMRC v BAA Limited [2011] UKUT 258 (TCC) (22 June 2011))
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 [2001] ECR I-1361 and BLP Group plc v Commissioners of Customs & Excise [1995] ECR 1-983).
- 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 [2005] ECR I-4357).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. In this German structure, the company, once set up, acquires all the assets, rights and obligations of the partnership. This is not a supply for German VAT purposes. In Faxworld, the partnership incurred VAT on certain transactions that led to its possession of assets that were later transferred to the company. The partnership never made (or intended to make) taxable supplies. 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 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. One of the effects of group registration is that supplies between group members are disregarded for UK VAT purposes.
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.
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. The representative member of the BAA VAT group appealed to the Tax Chamber of the First-tier Tribunal (FTT).
The FTT allowed the taxpayer's appeal and held that the BAA VAT group was entitled to reclaim the input VAT. Even though ADIL made no taxable supplies and the FTT found no evidence that, at the time the input VAT was incurred, ADIL had the intention to make taxable supplies, the fact that it subsequently became a member of the BAA VAT group was sufficient to permit it to be treated as a single entity with the other group members. For details of the decision, see Legal update, Input tax recoverable for share acquisition costs: Decision.
HMRC appealed to the Upper Tribunal (UT) on the ground that the FTT erred in law in allowing recovery of the input tax. BAA cross-appealed against the finding that there was no evidence of ADIL's intention to join the BAA VAT group before completion of ADIL's acquisition of BAA.
Decision
In its decision released on 22 June 2011, the UT, comprising Proudman J and Julian Ghosh, QC, allowed HMRC's appeal and dismissed BAA's cross-appeal.
Passive holding company or active economic operator?
Looking first at the question of whether ADIL was, as HMRC claimed, simply a passive holding company (which would conclusively bar the recovery of the input VAT on the invoices), the UT upheld the finding of the FTT that it was not. ADIL had an economic activity (the highest level of strategic and financial direction for the UK airports' business) and had acquired the shares in BAA as a first step in the process of achieving this management control. Nevertheless, it made no taxable supplies of its own (absent the VAT grouping rules), nor was there any evidence of its intention to make such supplies at the time the professional fees were incurred. It was not, therefore, possible to attribute the input VAT to any onward taxable supplies made by ADIL itself.
Recovery of input tax against supplies by successor entity
The UT disagreed with the decision of the FTT concerning the relevance of the German case of Faxworld (see Recovery of input tax against supplies by successor entity), The FTT found there to be a direct and immediate link between the fees incurred by ADIL and the taxable supplies made by the BAA VAT group of which ADIL became the representative member. The UT found there to be no such link and did not consider the two cases to be analogous. Whereas the purpose for which the Faxworld partnership incurred the input VAT was preparatory to the making of taxable supplies by the Faxworld company, the taxable supplies of the BAA group would have been made regardless of whether the group had been taken over by ADIL. The UT drew the distinction between the takeover of a business and the acquisition of shares representing that business (Faxworld involving the former and the present case involving the latter), noting that the principle of fiscal neutrality did not demand that the two types of transaction be treated the same or that the grouping rules have retrospective effect (see below).
Imputation of inputs and outputs within a VAT group
ADIL joined the BAA VAT group in September 2006, three months after its takeover of BAA. The UT found that the input tax incurred by ADIL could not be attributed to the VAT group because the grouping provisions are not retrospective. Having found no evidence of ADIL's intention to join the BAA VAT group pre-completion, the UT did not view the takeover costs as preparatory to the making of taxable supplies by the BAA VAT group. Therefore, the UT found no direct and immediate link between the supplies made to ADIL and any onward supplies either made by, or attributed to, ADIL.
Comment
The decision, although perhaps not entirely unexpected, will be disappointing for companies involved in significant takeovers in similar circumstances. If the input tax on pre-acquisition costs cannot be offset against the output tax of other members of the VAT group, is there any other means of reclaiming it?
During the course of the hearing before the FTT, it was confirmed that, as ADIL was carrying out an economic activity, it would have been in a position to recover the input tax if it had made onward taxable supplies in its own right (by invoicing management charges to BAA group companies). However, from the UT's deliberation of the point (paragraph 73 of the judgment) there is considerable doubt as to how much, if any, of the input tax on the fees would have qualified as having a direct or immediate link with the management services provided by ADIL. In the UT's view, any continuing benefit of acquiring the shares (such as putting ADIL in a position to provide strategic management) was too remote to provide a direct and immediate link to taxable supplies by ADIL, even if it were established (which it was not) that ADIL had intended before the takeover to provide and charge for those management services.
Therefore, following this decision, it appears doubtful that much of the input tax incurred on services relating to corporate takeovers can be recovered. However, the fact that ADIL was found to be carrying on an economic activity is extremely positive and bidders currently undertaking similar transactions should take all possible steps to maximise the chances of recovery, whether or not BAA appeals this decision. As early as possible in the takeover process, the bidder should:
- Register the acquisition vehicle (A) for VAT.
- Document (in board minutes or otherwise) A’s intention (so that it is firmly established that such intention was formed before completion) to carry out economic activities (that is, provide taxable management services to target) and that it is not a passive investment company.
- Document A’s intention to join or establish a VAT group with target immediately following acquisition of target.
- Once the acquisition is complete, immediately apply for group membership (from the date of acquisition) and start providing and charging for management services. .
Although that paves the way for VAT recovery, it will not guarantee it. It will also be necessary to look at the fees themselves and decide whether they relate solely to pre-takeover/acquisition advice or whether there is some continuing benefit or relevance post-completion. If part of the advice relates to post-completion periods, professional advisers should ensure that letters of engagement/invoices provide a clear breakdown.