The ability of holding companies to recover VAT on costs incurred continues to be hotly contested by HM Revenue & Customs. As such, companies must plan in a careful and timely manner to protect their VAT recovery regarding refinancing, restructuring deal transactions, and ongoing operating costs.
There have been several recent developments in UK and EU case law, and these provide useful guidance on the key principles.
These are summarised below, along with some essential planning points. The April 2021 Upper Tribunal decision in the case of Tower Resources Plc [2021] UKUT 123 could provide a “roadmap” of the steps holding companies should take to ensure they have an economic activity that results in the making of taxable supplies and consequently an entitlement to recover VAT.
Holding companies – what are they, and what do they do?
The traditional concept of a holding company is a company that acquires and holds shares in subsidiary companies and receives dividends that are outside the scope of VAT. However, such entities can be engaged in several additional activities, actively managing subsidiaries and providing services for consideration.
The nature of those activities will directly affect the holding company’s ability to recover VAT on the costs it incurs.
Suppose the holding company just passively receives dividend income. In that case, it cannot register for VAT in its own right as it is engaged exclusively in non-business investment activity, as demonstrated in the cases of Polysar (C-60/90) and Larentia + Minerva (C-108 and C-109/14). While active trading in shares can be an exempt business activity (noting potential VAT recovery in the sale of shares to overseas recipients), the occasional or simple sale of shares by a holding company would not be regarded as an economic activity.
Carrying on an economic activity
In order to register for VAT and recover VAT on costs, the holding company would need to be carrying on a taxable business activity (or “economic activity”) for VAT purposes. On the assumption they will not trade with 3rd parties, in addition to the typical passive, non-business activities undertaken, holding companies could be ‘active’ for VAT purposes via the provision of management services to subsidiaries.
Such services typically cover strategic advice, accounting, administrative, and IT services, which are usually subject to standard-rated VAT, as shown in the cases of Cibo Participations SA (C-16/00) and Floridienne (C-142/99). Additionally, the leasing of commercial property to a subsidiary would be exempt subject to an option to tax, in the case of Marle (case reference needed).
However, it is essential that any such arrangements are well planned and structured, have substance and commercial rationale, are genuinely carried out, and are well documented, as various cases have shown several areas of challenge here.
Practical issues
However, many cases have shown that even where there are agreements for management services to subsidiaries, the practical arrangements have undermined the notion of economic activity. It is important to note that supplying services does not necessarily amount to economic activity. There is a requirement that the service activity is conducted with a degree of regularity and sound business principles.
In the case of MVM (C-28/16), management services were provided but not paid; other cases lacked a repayment schedule (African Consolidated Resources) or suggested future payments but did not specify when (Norseman Gold [2016] UKUT). These instances displayed a break in the link between supply and consideration, as did the notion of contingent fee arrangements as found in the case of Bluejay Mining. Here, the payment was dependent on the profitability of the subsidiaries, resulting in no contractual expectation of the holding company ever being paid for its services.
The case of Larentia + Minerva showed management charges were made to some subsidiaries but not all, and this raises a question as to whether VAT recovery should be restricted on that basis.
Tower Resources Plc
In the recent Upper Tribunal case of Tower Resources Plc, HMRC had appealed the FTT decision because there was no written agreement in place for the management services, and the payment by the subsidiaries was on a contingent basis, which would contradict the reciprocal nature of supply and consideration.
However, the Upper Tribunal agreed with the FTT decision, that there was, in fact, an agreement (albeit not in writing), and that the consideration for the management services were booked to an intercompany loan account, the balances of which were repayable on demand. The obligation to pay, therefore, was found not to be either contingent nor uncertain. This was a resounding win for the taxpayer. It is worth noting that the Upper Tribunal decision creates a legally binding precedent. At the time of writing, it is not known whether HMRC will seek to appeal the decision.
Key planning points
In light of the various developments in the courts and to HMRC guidance, the following key planning points should be considered:
- Plan early to set up and establish the intentions and commercial rationale of the holding company and consider the basis for VAT registration and recovery.
- Where providing management services to subsidiary companies, ensure management agreements are in place, match commercial reality, have substance, and are correctly valued. A further area of potential challenge is where there are common directors of the holding company and trading subsidiary; in this situation, it may be the case that no services are provided when charging for the directors’ time.
- The arrangements should be backed up with proper invoicing and payment.
- Engage directly with advisors, ensuring contracts are consistent with commercial reality and that VAT is correctly charged by suppliers.
- Ensure direct and immediate link with taxable business activities, and apportion/restrict VAT recovery where there is exempt business income or non-economic activities.
- If including a holding company in a VAT group, that would not in itself give rise to VAT recovery. The holding company would still need to be carrying out a taxable business activity.
We will no doubt continue to see further updates to HMRC guidance as the matter is still very much a subject of challenge. HMRC often takes an aggressive stance due to large amounts at stake, the varying complexities, and because the cases are very fact sensitive. Businesses must be aware of these issues and plan at the earliest opportunity. They may wish to consider seeking professional advice to help navigate and overcome the various pitfalls.