Larentia + Minerva: VAT groups and holding companies

Advocate General Mengozzi (the AG) of the CJEU has recently given his Opinion on the case of Larentia + Minerva regarding: (i) the ability of a holding company to recover VAT; and (ii) whether it is lawful to restrict VAT groups to corporate bodies.

This is a potentially helpful judgment for those looking to recover VAT costs on M&A transactions.

Holding companies

Input tax incurred on acquisition costs

Larentia + Minerva had incurred input tax in raising capital from a third party which it used "to fund the acquisition of shareholdings in subsidiaries and [the provision of] services, in particular administrative and consultancy services, provided to those subsidiaries for remuneration". The subsidiaries took the form of limited partnerships.

The German supreme court considered that the input tax was used both for the services provided to the subsidiaries (referred to by HMRC as "business activities") and the acquisition of the shareholdings ("non-business activities") but could not decide how it should be apportioned.

Input tax should be recoverable in its entirety

The AG looked at the underlying question of "whether the holding companies' involvement in the management of the subsidiaries should … lead to the conclusion that such holding companies exercise only an economic activity … to the exclusion of any non-economic activity", and concluded that it did. If the CJEU follows this Opinion, it would seem that input tax incurred on the acquisition of subsidiaries would be recoverable in its entirety on the grounds that the only supplies made by the holding companies were taxable supplies.

Recent HMRC guidance, by contrast, has stated that a holding company can only recover input tax to the extent that it is attributable to the holding company's taxable supplies.

Thus:

• a holding company supplying no services to its subsidiaries could not recover input tax at all; and
• a holding company with some business activities, such as the provision of management services to its subsidiaries, and some non-business activities, would be able to recover input tax but only to the extent that the costs have a direct and immediate link to a taxable supply, i.e. the costs must be used for the purposes of the holding company's taxable supplies.

A CJEU decision following AG Mengozzi's Opinion would override HMRC's guidance for holding companies with some business activities, e.g. those which provided management services, and enable them to recover all input tax (except, of course, where it related to VAT-exempt business activities). This would clearly be financially advantageous for such holding companies, and would also have the benefit of avoiding difficult determinations of how direct and immediate the link to the taxable supply needs to be.

There is a four-year time limit for VAT refund claims, and accordingly any clients which may benefit from any such decision should consider making protective claims.

Partnerships in VAT groups

The EU VAT legislation permits member states to operate VAT groupings, i.e. to treat several persons as a single taxable entity where they are established in the territory of that member state and, while legally independent, are closely bound to one another by financial, economic and organisational links (Article 11 of the VAT Directive). However, Germany's implementation of Article 11 does not allow a partnership to be a member of a VAT group other than a representative member because it lacks a hierarchical status.

Requirement for legal personality and "control" relationship breaches EU law

The AG considered that a requirement for all members of a VAT group to have legal personality (with the effect that partnerships are excluded) breaches EU law unless that condition is necessary to prevent abusive practices, tax evasion or avoidance. Although the AG noted that this would be for the national courts to determine, he made it clear that he could not see that a distinction based on legal form or the existence of legal personality could be necessary and appropriate to prevent tax evasion and avoidance.

Similarly, the AG thought that national legislation requiring a relationship of control and subordination between the members of the VAT group also breached EU law as being an unnecessarily narrow implementation of the condition that VAT group members have close financial, economic and organisational links. Again, he did not see an obvious link between this restriction and preventing tax avoidance.

Impact on UK VAT grouping rules

This is important to the UK which also requires members of a VAT group to be corporates and subject to a relationship based on control. If the CJEU follows this Opinion, the UK could therefore be required to amend its VAT grouping rules to remove these restrictions and align the membership criteria more closely to those in the VAT Directive, i.e. close financial, economic and organisational links. A far wider membership of VAT groups could then be possible.

Larentia + Minerva - AG Opinion

Please click on the links below for the other articles in the May 2015 tax newsletter:

• Treaty abuse - OECD BEPS project
• Diverted Profits Tax - update
• Samarkand: film partnership scheme
• Southern Cross: compromise agreements with HMRC
• Price, Myers & Lucas: loss scheme using CGT options