A recent opinion from the European Courts – if ratified - will affect the recovery of VAT on corporate finance deals and other holding company costs. It could also change the rules on membership of a VAT group registration.
The Advocate General (AG) of the Court of Justice of the European Union (CJEU) has recently issued an opinion in a case concerning two limited partnerships that acquired shareholdings in subsidiaries.
In the joined cases of Larentia + Minerva mbH & Co. KG and Marenave Schiffahrt AG (Larentia + Minerva), referred to the CJEU by Germany, the AG's opinion dealt with two issues:
- Whether the partnerships were entitled to recover VAT on acquisition costs, and
- Whether partnerships were eligible to join a VAT group registration.
VAT recovery for holding companies
The opinion in Larentia + Minerva considers the extent to which a holding company can recover VAT on the costs of the acquisition and financing of subsidiaries. In the UK, this issue has been the subject of a long running dispute between taxpayers and HMRC.
HMRC's detailed guidance on VAT recovery by holding companies, issued last September, set the bar very high. Many stakeholders have voiced their disagreement with important aspects of HMRC's views.
HMRC has pledged to review its policy once Larentia + Minerva has been fully decided in the CJEU. Most UK appeals on this issue have since been stood over behind that case.
The AG's opinion
The AG believes that expenditure connected with capital transactions has a direct and immediate link to a holding company's economic activity as a whole and so the VAT incurred is recoverable in full, unless the company is partly exempt. The AG made clear that there should be no apportionment of input VAT to the 'non-economic' activities of a holding company.
As a result, providing a holding company makes taxable supplies, eg of management or administrative services, to its subsidiaries for remuneration, the VAT it incurs on acquisition costs is recoverable and is not subject to any 'non-business' restriction.
The opinion is very positive for the taxpayer as it states clearly that (in principle) VAT is recoverable on capital transactions. However, the AG's comments on the practicalities of demonstrating this are more nuanced.
The opinion suggests that, where management charges are made, a holding company can recover input tax related to the acquisition of shares in subsidiaries, so joining a VAT group ought not to be necessary to achieve this. However, if a holding company and its subsidiaries are VAT grouped, any recharge will not itself give rise to a right to deduct and the holding company must look to the activities of the VAT group as a whole to determine its entitlement to VAT recovery.
What does this mean for UK deal costs disputes?
Whilst an AG's opinion is often a good indicator of how the case may be finally decided, CJEU judgments can, and frequently do, differ materially. It is, therefore, not possible to make a firm assessment of the implications of Larentia + Minerva until the CJEU's final judgment is released.
Although not stated in the opinion, the need for management charges to secure VAT recovery suggests it would be prudent for anyone making an acquisition of subsidiaries to put in place, between the bid vehicle incurring the costs and the subsidiaries acquired, a management services agreement.
Holding companies that are VAT grouped with those subsidiaries should consider whether they can show that the deal costs are a cost component of supplies made to third parties by the VAT group as a whole.
What should I do in the meantime?
The VAT recovery position of deal fees and holding company costs has been in dispute for many years, with many sub-issues and arguments developing. While Larentia + Minerva looks set to make a significant impact on the position, it seems unlikely that this one case will resolve every appeal stood behind it.
If you have an appeal lodged, you may need to await the final judgment in Larentia + Minerva and HMRC's response. However, if your dispute concerns the subject of who can claim the VAT on deal costs you should speak to your usual BDO VAT specialist as HMRC's policy in this area is already progressing.
If you are planning a new corporate transaction, you should ensure the transaction is properly structured with documentary evidence in place to support VAT recovery. It is best to seek expert advice in the planning stage and before engagement terms are finalised.
The AG's comments on VAT group registration
EU VAT law permits businesses 'closely bound to one another by financial, economic and organisational links' to form a group registration for VAT purposes. VAT group treatment can bring a number of monetary and administrative benefits, including both cash flow and absolute VAT savings from the removal of the requirement to charge VAT on intra-group transactions and the elimination of exempt supplies on intra-VAT group financing arrangements.
One of the UK's conditions for VAT group membership is that the prospective member must be is a corporate body. This allows for the inclusion of limited liability partnerships (with some relaxations to admit limited partnerships in certain circumstances) but not general partnerships. The AG's opinion now casts doubt over the UK rules which debar general partnerships from joining a VAT group.
The AG believes EU law only allows member states to impose conditions designed to prevent VAT groups being used for tax avoidance and evasion. The AG believes barring a business from a VAT group solely because of its legal form is unlikely to fulfil this objective. Indeed, it could contravene European rules on fiscal neutrality if unincorporated businesses are prevented from enjoying the benefits of VAT group registration.
If this view is upheld in the final judgment, it could vastly widen the scope for the types of entities that will be eligible to join a VAT group in the UK. The AG's comments would appear to open the door not only to general partnerships but also to unincorporated associations and, potentially, even a sole trader, where the sole trader controls the group.
The AG says that it should be for the national courts of EU member states to decide whether their country's law is correct on this point. If the AG's view is upheld separate litigation may need to be brought before the UK courts, unless the European Commission is persuaded to commence infraction proceedings. In either case, such sweeping changes are unlikely to happen overnight and it may take some time before VAT grouping rules in the UK could be relaxed in this way.
The CJEU's judgement
The final judgment on these cases is expected to be released in summer 2015.
Businesses affected by either the deal fees/holding company issue or the VAT group registration issue should make sure they are ready to consider the impact of the judgment when it appears.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
