VAT recovery by holding companies - HMRC publishes new guidance

The ability of holding companies to recover VAT on supplies made to them for the purposes of their own or group activities as a whole has long been a tricky subject. A number of cases have highlighted issues in this area over the last couple of years (for example Larentia + Minerva, Airtours and Norseman Gold) and HMRC has now updated its guidance to reflect changes to its approach necessitated by these cases.

It is worth remembering, when considering the VAT position of holding companies, that the general principles still apply. It is simply that the nature of these companies raises specific and difficult concerns. In particular, one needs to be clear:

(a) that the services have in fact been supplied to the holding company;
(b) that the holding company is carrying out an economic activity; and 
(c) that the services were received for the purposes of a taxable transaction.

Is the holding company the recipient of the supply?

The issue here most commonly arises on the use of a new Bidco to acquire subsidiaries, although the key case on this point (Airtours) came up in the context of tripartite contracts. In Airtours, the company was unable to recover the input VAT incurred on professional services in connection with a reorganisation because, on the facts, the supply had been made to the banks and other creditors to whom the accountants' reports were addressed, and not to Airtours even though it had been Airtours paying for the services.

The decision in Airtours means that the supplier must be contractually obliged to the recipient to supply the goods or services, which may be difficult if Bidco has not yet been formed when engagement letters are entered into with suppliers.

Helpfully, HMRC confirms that this may be achieved through novation: "HMRC consider that a holding company is the recipient of the supply where it has contracted for the supply, including by novation…" However, HMRC goes on to state that it is also necessary that the holding company "has made use of the supply, been invoiced and paid for the supply". As is apparent from Airtours, it shouldn't strictly be necessary for the holding company to make the payment but, given this guidance, it would be sensible to ensure that this is the case wherever possible anyway. 

Does the holding company have an economic activity?

It is clearly established that the holding of shares is not an economic activity unless the holding company is participating in the management of its subsidiaries (or carrying on a trade of dealing in shares).

In the past, HMRC's guidance required costs incurred on the acquisition of subsidiaries to be recouped, by way of charging for services provided to subsidiaries, within a five- to ten-year period. This was a contentious policy, implicitly discredited in recent case law, and has now been dropped from the guidance. It is worth noting, however, that HMRC is still pursuing a variant of this argument - the question of whether, where overheads are entirely recouped by charging for exempt transactions but not for taxable transactions, no input VAT should be recoverable (as opposed to the proportion indicated by the company's partial exemption split) has now been referred to the CJEU in the case of Volkswagen Financial Services.

The guidance now focuses more closely on the services provided to subsidiaries in order to amount to an economic activity.

Recent case law indicates that there must be a direct link between the services provided and the payment, which might be evidenced either by a bespoke agreement or by ensuring that the value given is linked to the services rather than the amount which the recipient is able to pay.

Either way, the guidance is clear that the consideration charged for the services must be more than nominal and that payments contingent on a subsidiary's profitability will not be treated as sufficient consideration for these purposes as the arrangements then lack the necessary reciprocity to form a direct and immediate link between the services and the consideration.

It will be important to ensure that management service agreements contain payment provisions – when, how much and for what specific services – which are sufficiently certain to give comfort on this point.

However, if a holding company makes taxable supplies only to some, but not all, subsidiaries then it will still be necessary to apportion the VAT incurred on the cost of acquiring these subsidiaries between the economic and the investment activities. 

Similarly, a holding company which both provides taxable management services and exempt loans to subsidiaries will be required to apportion any VAT incurred on costs relating to the holding between the taxable and exempt supplies in line with the company’s partial exemption method.

A holding company will also be able to recover input tax on supplies received for the purpose of an acquisition if the holding company carries on a business of its own and acquiring the subsidiary was a "direct, continuous and necessary extension" of the holding company's taxable economic activity. In these circumstances, no management services need be provided to the subsidiary in order for the input tax to be recovered.

An example of this type of extension to a holding company's existing economic activity might be the acquisition by a trading company of a subsidiary owning a property from which the trading company intends to trade, or the acquisition of a complementary business such as a supplier, in contrast to an acquisition simply to increase dividend income.

Does grouping the holding company with its subsidiaries assist VAT recovery?

HMRC's view is that VAT grouping does not, of itself give rise automatically to an entitlement to recover VAT. The holding company's ability to recover input tax is still dependent on it carrying on an economic activity or being able to demonstrate a link between the input costs and the taxable activities of the other members of the VAT group. 

Superficially, this is attractive as HMRC states that the holding company should be able to recover VAT on costs incurred in making interest-bearing loans or other exempt supplies, as well as on providing management services to such companies with which it is VAT grouped provided that these can be seen to support the making of taxable supplies by the VAT group (identifiable by "looking through" the supply chain within the group).  This may confer an advantage over a standalone VAT registration for the holding company.

This is a slightly troubling statement, however, as it does not fit well with the general disregard of transactions between members of a VAT group. There is therefore a concern that, in grouping the holding company with its subsidiaries, management services would need not only to be for genuine consideration but also to be linked to the VAT group's taxable outputs in a way that may be difficult to establish. We would be surprised if the outcome of VAT grouping was to place more onerous requirements on a holding company but, if management services are to be provided and there are no other overriding considerations pointing towards grouping, it may be worth retaining a separate VAT registration for the time being. 

Separately, HMRC has confirmed that stewardship costs (that is, costs incurred by the holding company for the purposes of the VAT group as a whole such as group audit and legal, regulatory compliance, brand and bid defence costs) will be treated as residual costs linked to the VAT group.