Input VAT on costs of acquiring trading companies
This week has seen an important decision in the Court of Justice of the European Union (CJEU). The case is that of Larentia + Minerva (c-108/14 and c-109/14). It deals a heavy blow to UK policy on two important issues, VAT reclaim on costs of acquiring and managing trading subsidiary entities, and the scope of the permissible membership of a VAT group.
The issue was whether, if a holding company (or equivalent, such as a partnership) acquired ownership of a separate entity which carried on a business (such as a subsidiary company), and intended to involve itself in that entity’s management, for which it would charge fees to that entity, the holding company would be able fully to reclaim VAT on the acquisition costs and on the costs of on-going involvement in the subsidiary’s affairs. Alternatively, could it only reclaim a proportion, and if so, how would it calculate the proportion?
The reason for this question is the principle that mere holding of shares in a trading company is not a ‘taxable activity’ but merely an investment. The costs of such an investment cannot be subject to VAT recovery, since the costs have no direct and immediate link with taxable supplies of the subsidiary. But if one actively manages the subsidiary, that creates a link with the subsidiary’s taxable activities. We, in the UK, have tended towards the view that this meant that the scenario where there is active management involved VAT recovery, whereas the passive investment model involved no recovery. The issue raised by Germany in the Larentia + Minerva case was whether there was a halfway house, and that some of the VAT incurred on acquisition related to the investment and only part to the active involvement.
I say that the UK tended to view things as an ‘all or nothing’ in the past, but in fact that has come under challenge in certain quarters of HMRC in recent months, which has manifested itself in policy statements which have been included (probably out of caution) in the official Manuals which are designed to serve the needs of VAT inspectors and not the tax payers as such (though they are public and can be consulted by tax payers and advisers). These statements have not been published in R&C Briefs or in HMRC’s Notices. Nonetheless, they are extant statements of policy. These are in effect that, unless management charges made from the acquirer to their subsidiary are of sufficient scale to earn back the costs of acquisition in a reasonable timeframe – say, five years – the VAT on the acquisition costs would need to be apportioned to recognise a pure investment element in the original cost. This explicitly states that part of the use of the costs can thus be deemed to be pure investment use and thus non-recoverable. Their policy (as long as it remains extant on their web site) can be found here: Policy
In fairness to HMRC, there is another page in the manuals that says that the policy will be shaped by the outcome of Larentia + Minerva, and this suggests that the time for a revision of this policy is nigh. And that is because, as I say, the CJEU decision in that case was released on 16 July; and it did not go well for HMRC.
Put simply, the CJEU decided that the VAT on such costs was fully recoverable as long as the acquirer was involved in the management of the subsidiary and made charges for it. Which is what the rest of us have thought for a long time. The exception (apportionment) would only arise where and to the extent that there were companies that were acquired purely for investment purposes and no management for charge was involved. In practice, most acquirers will either manage all investments or none. It is going to be rare for there to be hybrids. Here is the decision for those who wish to read further: Decision
My only further comment is that this also impacts on HMRC’s wider application of what is called ‘cost component’ theory, about which I have commented in other articles. It is another nail in the coffin of this theory, which basically requires prices of supplies to reflect absorption of values of related costs in order for full VAT recovery to be available. The coffin is now all but fully nailed down; and its undertakers are digging the six foot pit. Before long I shall be reporting on the completion of its funeral.
UK VAT grouping rules only allow corporate bodies to join VAT groups. As I mentioned in my book: VAT Registration Handbook (published in 2014 by Claritax Books), there appears to be no reason for restricting membership to corporate bodies. Membership should be equally available to sole proprietorships and partnerships, and unincorporated associations. Well, this too was at issue in Larentia + Minerva. The German authorities do not allow a ‘non-legal’ entity to be a member of a VAT group (as regards which their objection is to partnerships, which in Germany, as in England, are not legal persons as such). The CJEU has decided that this restriction cannot be justified unless it can be shown to reduce fraud or abuse. Absent such a justification, the limitation of membership to corporate bodies is invalid. Unfortunately, for technical reasons, the court has decided that it is not possible for UK entities to apply for grouping on the basis of ‘direct effect’ of the provisions of the Principal VAT Directive. But we can expect the UK to pass legislation allowing wider grouping since it is now clearly in the position of infringing EU law. Let’s hope that it does not wait to be goaded by the EC Commission before reforming the ultra vires UK legislation. In the meantime, unincorporated associations, partnerships, and sole proprietorships, could perhaps apply to be included in a group registration to make a point, and it may meet with reluctant acceptance if the decision in Larentia + Minverva is cited.
Anyone who wants to discuss either of these issues with me, please contact me at firstname.lastname@example.org