VAT groups, acquisitions and fundraising

The FTT has held that input VAT incurred by a holding company on a reverse takeover and fundraising transaction was not recoverable as input VAT: Ince Gordon Dadds LLP v HMRC [2023] UKFTT 44. Although the FTT accepted on the basis of the BAA decision, that input VAT incurred by a holding company might be properly attributed to the downstream activities of the VAT group of its target provided that it intends to join that target’s VAT group, the input VAT in this case did not qualify. To the extent that the input VAT was incurred to raise extra finance, the use of those funds to acquire additional investments in subsidiaries did not meet the test in Frank Smart that, to be deductible as overheads, such funds must be used to fund its economic activity and develop its business.

The decision shows the complexities of the issues around recovery of input VAT by a holding company in its acquisition of a target and the need for early tax advice to ensure that any possible recovery is maximised.

Background

In 2016, WG acquired the shares in a company, Culver, by way of a reverse takeover. Culver was, prior to the reverse takeover, the holding company of a group of companies which provided legal and professional services and financial advice. Culver supplied management services to its subsidiaries for consideration. WG had previously carried on similar activities to those of the Culver group, but had ceased carrying on those activities about 20 months before the reverse takeover. The arrangements involved a share for share exchange and, simultaneously, WG also sought to raise approximately £20m in cash through a placing of new ordinary shares in WG.

WG incurred input VAT on professional costs in relation to the transaction (known as Project Kappa), including legal fees, accountancy fees and fees for the admission of the shares on AIM. On the same day that the transaction was completed, WG became a member of the Culver VAT group. It sought to recover that VAT as input VAT. HMRC disallowed the input VAT on the basis that WG itself did not, at the time of the takeover, make or intend to make supplies within the scope of VAT.

FTT decision

WG sought to argue that the input VAT incurred by it should be attributed to the taxable activities carried out by the Culver VAT group either:

• The supplies were properly treated as made to the VAT group representative (Culver) which was carrying on a taxable economic activity of the group as a whole and the input VAT formed part of the overheads of the VAT group representative and were recoverable as such: or
• On the basis that section 43 deemed the input VAT to be matched to the VAT representative member’s supplies.

Attributing the input VAT to the group’s taxable activities

The FTT accepted that where BAA applies, the following principle will apply: where a company acquires another company, the taxable supplies or future taxable supplies, and the economic activity or future economic activity, of the company acquired can be relied on as the intended “downstream” taxable supplies and intended “downstream” economic activity of the acquiring company, where the acquiring company intends to join the VAT group of which the company acquired is a member.

BAA involved a third party Bidco, formed to take-over BAA by acquiring its shares. There was no evidence that that Bidco undertook or intended to undertake any economic activity at the time it incurred the VAT. In addition, it did not at the relevant time intend to join the VAT group of which BAA was a member. In this case, the FTT accepted that WG always intended to join the Culver VAT group on completion of the transaction. Given that the condition specified in BAA – intention to join the acquired company’s VAT group – was met in the present case, the FTT accepted that Culver’s economic activity can be relied on in principle as “downstream” current or intended economic activity of WG.

(The FTT also considered the issue of the time at which the “intention” to join the VAT group needed to be present. Was this the time when the costs were incurred or the time of supply of those costs for VAT purposes (which was actually after WG joined the Culver VAT group)? The FTT noted that the Court of Appeal held in BAA that the intention to make taxable supplies is to be considered as at “the date on which ADIL [the company effecting the takeover] incurred the liability to VAT on the services supplied to it”. Without seeming to resolve this issue, the Tribunal took into account (i) intentions that existed at the time that WG received the services supplied and (ii) intentions that existed at the time of the takeover. The post-takeover situation was also relevant in considering what the funds were in fact used for.)

WG contended that the input VAT in this case amounted to deductible “overheads” - the overheads being the cost incurred by WG in fundraising as part of the takeover. The FTT also accepted, on the basis of the decision of the Supreme Court in Frank Smart, that the cost of fundraising can, in principle, be an overhead. The test applicable was set out in the Supreme Court judgment in Frank Smart:

“Where the taxable person acquires professional services for an initial fund-raising transaction which is outside the scope of VAT, that use of the services does not prevent it from deducting the VAT payable on those services as input tax and retaining that deduction if its purpose in fund-raising, objectively ascertained, was to fund its economic activity and it later uses the funds raised to develop its business of providing taxable supplies.”

According to the FTT, the VAT on costs of fundraising is, pursuant to Frank Smart, recoverable where the economic activity intended was of the same company as raised the funds and received the supplies on which the VAT is sought. But Frank Smart did not undo BAA which had envisaged that – instead of an intention for the holding company itself to carry on an economic activity involving actual taxable supplies – an intention at the relevant date to join the VAT group would suffice. Accordingly, the FTT considered that it was appropriate to read Frank Smart with the rider – from the Court of Appeal in BAA – that economic activity by Culver and taxable supplies by Culver can be relied on as “downstream” economic activity, and “downstream” taxable supplies, of WG.

Did the input VAT in this case qualify as deductible input VAT on the basis of it amounting to overheads? That depended on the intended use of the funds. The evidence was that the £20m was raised in part to repay borrowings, in part to make acquisitions and in part to fund working capital. However, the FTT considered there was no firm intention as to how much should be used for acquisitions and how much for working capital. As such, the FTT looked instead at how the monies had been used. On that issue, the FTT considered that the only finding it could make on actual use was that it included the making of further acquisitions, that is, the purchase of further companies or entities, but it was unable to make a finding as to how much was so used.

The question was whether that actual use of the funds comes within the Supreme Court’s reasoning in Frank Smart. On this issue, the FTT held that the making of further acquisitions in this case was not a use of funds within the Supreme Court’s reasoning in Frank Smart.

The FTT held that the purpose of making further acquisitions in this case was so that the further acquired entities would be additional customers of Culver’s services (which services it accepted can be WG’s downstream activity). However, acquiring assets for those assets to be new recipients of economic activity and of taxable supplies is not using those assets “to generate … transactions” in the way meant by Lord Hodge in Frank Smart. The Tribunal noted that, “It is true that the acquired assets would conduct activity in the sense of purchasing Culver’s services, if the acquired assets were willing to purchase them. But that purchasing activity is done by the assets acquired, and not by WG or Culver.”

As a result, the FTT held that the fundraising in this case was not within the reasoning in Frank Smart. This was not because the taxable supplies were intended to be made by WG’s subsidiary rather than by WG. Rather, it was because the funds raised were used to buy assets which WG envisaged would be new customers of Culver’s economic activity and of Culver’s taxable supplies. Although acquisition of assets is in principle within Frank Smart, that particular use of the assets was not in the FTT’s judgment the kind of use of assets envisaged by the Supreme Court in Frank Smart.

(The FTT noted that, if they had held that the use of the funds did in principle qualify, it would have considered whether pro-rating was needed to exclude VAT on amounts for so much of the services received as related to the due diligence and advice for WG for the takeover. The question would have arisen as to whether WG’s costs of doing its own due diligence were a cost of the fundraising.)

Section 43

Finally, the FTT rejected the taxpayer’s argument based on VATA 1994 section 43. Essentially, WG argued that section 43 deemed the supplies to have been made to Culver and Culver was a fully taxable business. Therefore, it was immaterial that WG was not carrying on any economic activity for the 20 months prior to the takeover, or at the time of the takeover, because “the supply is treated as made to Culver Holdings Ltd as representative of the VAT group and the transactions were plainly for the benefit of Culver Holdings Ltd’s business (as group representative)”.

HMRC, in contrast, argued that joining a VAT group does not, of itself, give rise to an entitlement to recover VAT in a case such as this. It cannot change a non-economic activity into an economic activity. Nor does it automatically create a direct and immediate link between all input costs of a holding company and the taxable outputs of other VAT group members, unless (i) such a link can be traced through the intra-group supplies, or (ii) the input costs are such that they are properly and naturally attributable to the VAT group’s taxable outputs. VAT grouping has the effect that all supplies are treated for VAT purposes as made to and by the representative member, but if a member of a VAT group incurs costs which it uses for non-economic activities, then the VAT on those costs still relates to the non-economic activities and VAT grouping does not change that. The supplies are treated as being used by the representative member for non-economic purposes.

The FTT noted that such an exercise would convert all VAT into recoverable input tax in VAT group cases. In doing so, the FTT cast doubt on the correctness of the FTT decision in Heating Plumbing Supplies v HMRC [2016] UKFTT 753.

Comment

It might be noted that in this case there appears to have been no suggestion that WG would provide management services to the Culver group. As such, it was necessary to seek to rely on the activities of the underlying group to bring the VAT incurred by WG on the acquisition within the scope of the concept of input VAT.

In fact, the FTT in this case accepted that, since WG always intended to join the Culver VAT group, it could rely both on the economic activities and taxable supplies made by that group to, in principle, qualify. However, as the input VAT in this case was incurred on fundraising activities, it was also necessary to meet the tests set out in the Supreme Court decision in Frank Smart. This was the hurdle at which the case fell. In this case, the FTT considered that simply making further acquisitions of subsidiary’s that might, indirectly, lead to further economic activity of the group by buying services from the Culver group did not meet the test in Frank Smart. It seems that the potential for growing the business was too indirect in this case.