VAT on Investment Management Fees – and more besides
The ongoing debate between HMRC and charities concerning VAT recovery on investment management fees has reached an interesting point, and possibly the end of the road.
The background to this is that, income arising from investments (including disposals of shares) is regarded in most cases as outside the scope of VAT because the activity does not arise from a business when carried out by a charity. This point was established long ago, and it is the consequence of that point which is of interest. The question is whether the costs therefore relate to a charity’s entire activity or, instead, relate merely to the sales of shares from the portfolio under management. If the first, the cost is VAT-recoverable as though it was an overhead (and to that extent). If the second, then there is no link with taxable supplies and no VAT can be claimed whatever may be the charity’s general position.
HMRC (having initially accepted that the first approach was correct) began to refuse claims on this second basis, and thus precipitated litigation with, as it happens, Cambridge University. The case was heard by the first tier tribunal which decided in favour of the ‘overheads’ analysis advocated by Cambridge University. HMRC appealed to the Upper Tribunal, which has recently reconfirmed the first tier’s view. That perhaps ends the really interesting news, but I think there is more to this, and not merely more by way of arcane explanation. The way in which HMRC approached the appeal was revealing, and the rest of this note gives my thoughts on what appeared to happen.
HMRC takes a gamble
The first point to explain is that the basis for the favourable ‘overheads’ interpretation is the CJEU decision in the case of Kretztechnik. This case was about the costs of a rights issue, which were held to be overheads of the business as a whole and not costs that related solely to the non-taxable activity of issuing shares. This therefore departed from the much older CJEU decision of BLP where the costs of selling shares were regarded as solely relating to selling shares. However, these sales of shares were not the same as issuing new shares. The Court held that the sale of existing shares from the portfolio of BLP was an exempt supply which could not be ‘looked through’ to the purpose of supporting a taxable business (even though that was the motive for selling them). The rights issue was, said the CJEU, wholly different, in that a rights issue is simply not a supply, but merely a capital raising exercise. Thus there was nothing stopping the costs being treated as overheads. There was no ‘chain breaking supply’.
So, returning to charities, which do we think is the closer parallel here; the sale of shares from an investment portfolio by BLP (a commercial company), or the raising of capital by a rights issue? Most people would say that the parallel is with the first, since the activity is identical, only the fact of a charity being involved being the differentiator. But Cambridge University and the first tier tribunal said that the closer parallel was the raising of capital, because neither case involved the making of supplies within the scope of VAT, whereas the BLP sales of shares involved an exempt supply (which, though exempt, is an ‘economic activity’). This means that it is the fact that people accept that charity investment transactions are not an economic activity, unlike the counterpart in the commercial world, that makes all the difference, but we shall not critique that difference, because it is generally accepted to apply, which means that we need not consider whether it ought to.
But this still appears challengeable on the basis that the sale of listed shares by a charity must be a transaction, albeit not one that is within the scope of VAT. Why should the costs of a transaction be treated as an overhead merely by virtue of the transaction not being an economic activity? After all, the CJEU had made clear that the rights issue was about raising capital from investors, and the sale of shares was about raising cash from selling assets, and these are not the same. The key point, arguably, is that there is no supply of any kind in issuing shares, whereas there is a supply of a sort in selling assets. So perhaps the parallel with capital raising is strained to that extent.
As I say, the first tribunal listened to this but rejected it in favour of the alternative, but the decision was appealed, and I decided to attend the (public) hearing. I sat and waited for the argument to be re-presented by HMRC but found, to my surprise that they had abandoned that argument. This meant that they had to rely wholly on a secondary argument which was far more theoretical. It was that the cost of raising capital was, inherently, a cost of the whole business, whereas the cost of raising funding from selling assets had to be a ‘burden’ only on that asset sale. This, they said, was a separate point from the fact that the sale of assets is a supply and a rights issue is not.
Well, they duly failed in that argument as well (as they had before the first tribunal). The reason they failed is complicated but it is interesting to note that this second argument relied intensely on the concept that raising capital involved a bargain whereby the investor expected a return on the capital, and that this could only be generated by the underlying business, whereas if you sell assets, the customer only cares about his purchased assets, and not about the seller’s business. This, HMRC argued, meant that the cost of the capital raising was a cost related to the business as a whole, whereas mere fund-raising from an asset sale involves a cost relating solely to the raising of those funds.
It is an ingenious ploy, but it relied entirely on the view that the CJEU had decided that the key point was not so much that raising capital did not involve a ‘supply’ but that the raising of capital was in and of itself the key determinant because of the theory expressed above. The problem is that the CJEU did not mention the above concept. And, as is common with the CJEU, there was no clarity that the reference to raising capital was anything more than background factual material. The CJEU did not specify that the reasoning could only apply to raising capital. One of the judges in the Upper Tribunal hearing asked whether that could be demonstrated, and HMRC admitted it could not, but that it was a reasonable inference. The judges have turned out not to agree with that inference, and I think they were right not to.
So, HMRC lost their appeal, but why did they abandon their better point? Well, it was not because doing so would strengthen their secondary point. That very rarely applies as a point of legal principle. I think it is because they had a bigger target in mind than the VAT on investment management fees. I think it is because of a wider plan to succeed in restricting VAT recovery across a much wider canvas.
I think this because it would have helped their arguments elsewhere based on ‘cost component’ theory. This theory effectively says that VAT on a cost cannot be claimed except to the extent that the cost is built into prices of sales. To make out that point in the light of the CJEU’s view relating to a rights issue, they tried to argue that the cost of a rights issue ‘burdens’ the future supplies that will create the return on raised capital. But by the same token, the cost of selling shares ‘burdens’ only the sale of the shares, because the transaction does not create a specific obligation that engages the supplies made by the business. But that seems to imply that the level of price of these assets can be affected by the costs incurred in achieving the sale. That is, in all cases, a very difficult point to make out, because the price of almost all supplies are determined by the market, and only rarely by a cost-plus calculation. It is particularly misguided as an approach to the price of listed securities which simply cannot be affected in any circumstance by the costs incurred.
Had HMRC won on this basis it would have added lustre to the view that it is possible to reach an economic appraisal of where the burden of a cost falls and to use this as a means of hypothecating cost more successfully to non-taxable activities. This would have assisted in supporting HMRC’s policy of limiting input tax recovery on holding company costs and their putative challenge to input tax recovery by charities in cases where the costs of an activity are ‘a burden’ on voluntary income rather than on earned income. In recent days (far too late to cause a rethink by HMRC concerning this investment costs case) they have also suffered setbacks in regard to both these areas from opinions of advocate generals of the CJEU in the cases of Larentia and of Sveda. Now the Upper Tribunal has rejected them also on a related argument.
HMRC rolled the big dice, but luck was not a lady tonight.