Further update on the recoverability of VAT on fees for fundraising share disposals

We previously provided an update on the Upper Tribunal decision in the case of Hotel La Tour. This case appeared to open the door for certain businesses appealing to recover VAT on professional fees incurred in connection with VAT-exempt share transactions (provided that they were implemented to raise funds for downstream taxable supplies). This means they appeared to take a wider view and factoring in the intention of the share sale.

However, this Upper Tribunal decision has now been overturned in the Court of Appeal. The Court of Appeal was of the view that the VAT was irrecoverable on the basis that the professional fees were “directly and immediately linked” with the exempt share sale, being a distinct economic activity to which the VAT and costs could be attributed.

The decision undoubtedly adopts a more fundamental analysis of foundational VAT principles, which we explore here alongside the implications of this decision. It remains to be seen whether the taxpayer will seek permission to appeal to the Supreme Court and seek a decisive statement on this issue.

Background

For VAT on costs to be recoverable as “input tax”, those costs must be “directly and immediately linked” to taxable supplies (ie standard, reduced or zero-rated supplies). This has been a prevalent issue in the context of share and restructuring transactions which, when taken in their own right, are generally exempt supplies.

Where costs are directly and immediately linked to such exempt supplies, any VAT on those costs would normally be irrecoverable. Many businesses raising funds through share transactions have therefore asserted, as in this case, that the VAT on the associated costs is directly and immediately linked to the main economic activity of the business (ie making taxable supplies) as opposed to the exempt share transaction. This means they are looking to apply a wider interpretation of the “link” test.

This case involves a hospitality company seeking to recover VAT on professional fees incurred on the sale of a subsidiary company, the sale being initiated to raise funds for the construction of a new hotel in Milton Keynes. The Upper Tribunal had, on appeal from the First-tier Tribunal, confirmed that the professional fees incurred in connection with the sale were directly and immediately linked to the downstream taxable supplies (ie the development of the new hotel).

The Upper Tribunal was of the view that VAT on professional fees associated with exempt transactions can be recovered where the purpose is to raise funds for the business’s economic activity, the funds raised are used to make taxable supplies and the professional fees are a cost component of the taxable activities of the business.

The Court of Appeal decision

The Court of Appeal ultimately accepted HMRC’s key grounds of appeal in this case and expressed their view that the Upper Tribunal had failed to apply the direct and immediate link test correctly in light of the various European and UK cases. The Court of Appeal undertook a substantial review of the case law in reaching the contradictory conclusion to both the Upper Tribunal and First-tier Tribunal. In particular, the Court of Appeal was of the view that the Upper Tribunal’s analysis of where costs are incorporated (ie whether they are a cost component of certain economic activities) was misguided on the basis that this test or analysis was not generally supported in the case law.

Similarly, the Upper Tribunal had overstated how far the European case law had departed from the default VAT principles set out above. Lady Justice Whipple noted, in her leading judgment, that the “inputs were used in, were cost components of, were directly and immediately linked with, the exempt share sale. If incorporation is a test which stands separately (which I doubt) the costs were incorporated – in the sense of having an objective economic link to – in the sale of shares because they were used to make the share sale and were met from the proceeds of sale.” On this basis, the Court of Appeal had no problem finding that the VAT on the professional fees were wholly irrecoverable and the exempt supply (ie the share sale) had the effect of “breaking the chain” linking the costs with the downstream taxable activity.

What this means for you

The Upper Tribunal decision seemed to indicate that protective claims, to prospectively recover VAT on costs incurred in the previous four years, would be warranted in certain circumstances where the transactions had been carefully structured. This must now be revisited given the Court of Appeal’s interpretation of the direct and immediate link test.

Whilst the Court of Appeal recognised that professional fees on share transactions could, theoretically, be directly and immediately linked to downstream taxable supplies, the decision does significantly limit the circumstances where VAT recovery is viable and appropriate. Whilst the door to VAT recovery is perhaps not entirely closed, we recommend that businesses looking to raise funds to develop their main economic activities seek advice on the current VAT position.

If you would like to discuss any points covered in this insight in connection with any past, current or future transactions, contact our VAT specialists to explore how we can help.