Input VAT and share sales: BLP resurrected

The Supreme Court has unanimously upheld the decision of the Court of Appeal in HMRC v Hotel La Tour Ltd [2025] UKSC 46. The decision is important in the context of recoverability of input VAT incurred in connection with share sales and confirms that there is no different test for input VAT recovery in fundraising scenarios that overrides the normal "direct and immediate" test for input VAT recovery.

The judgment of Lady Rose (like the judgment of Whipple LJ in the Court of Appeal) contains an extensive review of the authorities in this context, including the CJEU decisions in BLP and SKF and the Supreme Court judgment in Frank A Smart & Son Ltd. The conclusion of her analysis is that the "direct and immediate" test originally set out in BLP remains fundamental, and whilst there has been some recognition that the test applies more flexibly in some cases not involving supplies, it has not been ousted in the context of a share sale either by the need to apply fiscal neutrality (in comparison to share sales not amounting to an economic activity) or replaced by a cost component approach. The CJEU decision in SKF simply involves a recognition that all input VAT incurred in the context of an exempt share sale cannot automatically be assumed to have a direct and immediate link with the exempt share sale; the full direct and immediate link test must still be applied.

The Court has also rejected the argument that management services provided intra-VAT group are ignored leading to the conclusion that no economic activity takes place. The VAT grouping rules do not involve ignoring the activities for the purposes of determining if there is an economic activity and, accordingly, whether the sale of shares in a managed subsidiary is an exempt supply (rather than outside the scope of VAT).

As a result, the Court has held that input VAT on expenditure incurred on a sale of shares was not recoverable despite the fact that the purpose of that share sale was to raise finance to further the wider taxable business of the seller.

The decision will be disappointing to businesses raising finance for taxable activities via the sale of shares in subsidiaries, where that sale amounts to an exempt supply. Quite when related costs might be directly and immediately attributable to the business as a whole (rather than the share sale) as recognised (at least in principle by SKF) remains an area of significant uncertainty and one which is highly fact dependent.

Background

Hotel La Tour Ltd (HLT) was a holding company and owned the whole of the share capital of a subsidiary, HLTB, with which it formed a VAT group. HLTB owned and operated a hotel and HLT provided HLTB with management services.

In 2015, HLT decided to construct and develop a new hotel in Milton Keynes. It was anticipated that this would cost approximately £34.5m. Various finance options were considered but, ultimately, the preferred option was to sell HLTB and to borrow the remainder. Accordingly, HLT sought to obtain the highest price possible for the shares. It was clear from board meeting minutes that from the outset the proceeds of sale of HLTB were to be used to fund the Milton Keynes Development. HLTB was eventually sold in 2017, raising approximately £16m from both the purchase price of the shares and repayment of debt from HLTB. HLT then commenced the development of the hotel in Milton Keynes.

In the course of the sale of HLTB, HLT incurred significant professional fees including VAT on those fees, including marketing costs, solicitors' and accountants' fees. It sought to deduct that VAT but HMRC took the view that the VAT was directly and immediately linked with the exempt sale of shares in HLTB and denied deduction.

The FTT accepted HLT's appeal, holding that it was possible to ignore the chain-breaking effect of the exempt supply of shares in a "fundraising" scenario such as this, provided that the relevant costs were not incorporated in (and thus a cost component of) the initial exempt transaction. The Upper Tribunal endorsed this decision, agreeing that it was clear from later decisions of the CJEU such as SKF and Sveda that the CJEU had moved away from the chain-breaking approach originally set out in BLP. The Court of Appeal overturned these decisions, concluding that there had not been a fundamental shift away from the direct and immediate link approach and that, in the case of an exempt share sale, BLP remained the appropriate approach. The Supreme Court has now unanimously upheld the decision of the Court of Appeal with the single judgment delivered by Lady Rose.

Decision of the Supreme Court

Having analysed in some depth the case law relating to recovery of input VAT by holding companies, Lady Rose noted that the issue for determination in this case essentially amounted to the following: "How does one determine whether the inputs acquired by HLT to assist with the sale of its shares in HLTB are directly and immediately linked with the specific transaction - the share sale - rather than with the taxable person's overall business having regard to the fact that the specific transaction is an exempt share sale?"

The taxpayer relied heavily on the CJEU decision in SKF, where, it argued, the CJEU considered the situation where essentially the same transactions could be either (1) outside the scope of VAT (sale of shares by pure holding company) or (2) exempt from VAT (sale of shares by holding company providing management services) but there was potentially a right to deduct input tax in (1) in accordance with Kretztechnik but, according to BLP, there was no right to deduct input tax in (2). The taxpayer argued that the CJEU applied the principle of fiscal neutrality to extend the same treatment to what would otherwise be an exempt transaction (which would break the chain between the supply of services and a taxpayer's general economic activities).

Lady Rose's judgment provides an extensive review of the relevant authorities in this area, including BLP and running through Midland Bank, Abbey National, Kretztechnik, SKF, Sveda, Securenta and finally Frank Smart.

The cost component approach

Firstly, the Court rejected the argument that the relevant costs could not be directly and immediately linked with the sale of the shares since they did not amount to a "cost component" of that supply on the basis that they did not impact the price of the shares. The Court cautioned against taking the terminology of "cost components" too far and noted that it was clear from the CJEU judgment in Volkswagen that it was not necessary for costs to have a direct impact on the price of an onward supply to have a "direct and immediate link" with it or be a "cost component" of the onward supply, indicating that "the cost component concept in the direct and immediate link is not what the CJEU applies, despite its continued use of the unhelpful phraseology".

The Court noted that such an approach would be particularly inappropriate in relation to a sale of shares. "Indeed, the reference to "cost components" is particularly inapt where the transaction under consideration is a share sale because sales of shares are very rarely priced on a cost plus basis." The Court of Appeal had been correct holding that the FTT and UT erred in their application of the case law, in so far as they relied on the way in which the price of the shares in HLTB was set in order to reject the possibility of there being a direct and immediate link between the inputs and the share sale.

Exempt and out of scope transactions

Based on the case law before SKF, the Court noted that the position taken by the CJEU had been clear in drawing a distinction between, on the

one hand, the principle in BLP that a transaction which is economic activity within scope is generally the transaction with which inputs have a direct and immediate link so that if that transaction is exempt, there is no deduction and, on the other hand, cases which show that if the transaction which consumes the inputs is out of scope then the inputs can be attributed to the overall business, so that the extent of their deductibility depends on the

composition of that overall business as between taxable, out of scope and exempt transactions.

Did SKF change this position? In particular, is SKF authority for the proposition that share sales which are exempt from VAT should be treated in the same way as share sales which are out of scope of VAT and that means in effect that inputs incurred in making the share sale are to be treated as directly and immediately linked with the taxable person's overall business and not to the share sale itself, at least where the proceeds of the share sale are used to fund the overall taxable business?

The Court noted that SKF is a difficult decision. "It is difficult to know how to interpret what the CJEU said in SKF. Whipple LJ was right when she said that "taken out of context, phrases and sentences can be found in the judgment to support both parties' submissions" and that it is important therefore to read the case as a whole to make sense of it."

However, the Court rejected the argument that the CJEU had applied the principle of fiscal neutrality to treat an exempt share sale and out of scope share sale in the same way. Firstly, it was clear that fiscal neutrality was not a governing principle that can justify ignoring the way the legislature has treated particular transactions as exempt or not. It is simply a principle of interpretation and not substantive law. Secondly, "the CJEU's concern in SKF about fiscal neutrality arose from the fact that the reason why a share sale is exempt or out of scope turns on the existence of the remunerated services provided by the parent company to the subsidiary. There is no logical connection between that test and the test for when inputs are treated as directly and immediately linked with a specific transaction rather than with the taxpayer's overall business. That was why the CJEU regarded it as contrary to the principle of fiscal neutrality always to treat an exempt share sale as precluding the deductibility of inputs, as BLP appeared to do".

Ultimately, the CJEU in SKF merely recognised that it cannot simply be assumed that inputs incurred in connection with a share sale have a direct and immediate link with that share sale and there may be a possibility that they have a direct and immediate connection with the general business. And such a possibility is not merely fanciful given that the facts of individual cases are infinitely variable. "What SKF decides is that one does not argue backwards from the fact that the share sale is within scope but exempt in order to conclude that the inputs must be directly and immediately linked with the share sale. In so far as HMRC made that submission in this appeal then I do not accept it. One must still argue forwards from an analysis of the connection between the inputs and the share sale to decide whether they are directly and immediately linked to that sale or to the general business. If they are directly and immediately linked to the share sale and the share sale is exempt then the inputs are not deductible. If they are not directly and immediately linked to the share sale but to the general business then the inputs may be deductible in whole or in part depending on the tax status of that general business."

"In my judgment, consistent with SKF, the application of the direct and immediate link test could lead to a different result depending on whether the specific transaction to which the input is putatively linked is exempt or out of scope. The factual and legal background that leads to the conclusion that the specific transaction is within the scope of VAT rather than out of scope may also influence the answer to the question whether the inputs were directly and immediately linked to that specific share sale or to the general business. HMRC's submission, which HLT accepted, was that it is more likely that inputs will be directly and immediately linked with the general business if the putative specific transaction is a supply made by a trader for which it does not charge consideration. That much is common sense, as is apparent from Sveda and Iberdrola."

Fund-raising transactions and the purpose of the share sale

Having concluded that the fact that the sale by HLT of its shares in HLTB was an exempt transaction was not the end of the matter and it was still necessary to apply the direct and immediate link test to determine whether the inputs incurred by HLT were directly and immediately linked to the share sale or with the overall hotel business which is taxable, it was then necessary to consider the taxpayer's argument (accepted by the FTT and UT) that the direct and immediate link test has been modified when it is applied to share sales, or other financial transactions, to focus on the purpose of the transaction and in this case the objective purpose of acquiring the services was to fund HLT's taxable economic activity.

In this context, the Court noted that there is essentially only one situation where the purpose of the taxpayer is relevant to VAT recovery - and that is where the taxable person is not yet carrying on any taxable activity but incurs the inputs for the purpose of a future taxable activity and claims

immediate repayment of the VAT from the tax authority on that basis. In those cases, there is a timing difference between the expenditure and the commencement of the economic activity and input VAT recovery will depend on the taxpayer's purpose. In particular, the Court rejected the argument that the Supreme Court decision in Frank Smart indicated that there is a wider principle that the taxpayer's purpose in incurring expenditure in all fund raising cases is relevant to VAT recovery. Frank Smart was a case that concerned the potential time lag between the incurring of the input VAT and the carrying out of the economic activity to which the taxpayer argued it was linked. As in Sveda, it was a case where the inputs were not immediately used for an economic activity.  

Accordingly, the Court held that Frank Smart was not authority for the proposition, in a case where there is no timing issue, that the purpose of the inputs is relevant to the identification of the transaction with which there is a direct and immediate link. Indeed, that would be directly contrary to CJEU authority which makes clear that generally speaking the purpose for which funds are raised is irrelevant.

Therefore, the Court rejected the argument that there is any modification of the direct and immediate link test in the case of a share sale and, on the facts as found by the FTT, the direct and immediate link test, when properly applied established that the relevant link in this case was the link between the inputs acquired by HLT and the sale of the shares in HLTB and not with the overall hotel business of HLT.

VAT grouping

The analysis of the Court so far depended on the assumption that HLT was carrying on an economic activity of providing management services to HLT and, accordingly, the sale of the shares in HLT was an extension of that economic activity and exempt from VAT. However, HLT also argued that since it and HLTB were part of the same VAT group, then any supplies between them were ignored for VAT purposes (VATA 1994 s.43). Since the supplies of management were ignored, then there was no economic activity and the sale of the shares was outside the scope of VAT (rather than exempt), such that recovery of input VAT should be on the basis of its overall economic activities (following Abbey National and Kretztechnik).

The Court rejected this argument. Various authorities have emphasised the limited effect of the statutory fiction contained within s 43. The VAT grouping provisions do not mean that activities are disregarded for all purposes, nor that the facts can be overlooked. The statutory fiction is a simplification measure for VAT accounting purposes. Notwithstanding the existence of a VAT group, HLT and HLTB retained their individual identities, and economic activity was still taking place (constituted by the management services provided by HLT to HLTB). "Although they were members of the same VAT group, HLT and HLTB retained their individual identities. Economic activity was still taking place between them because HLT was engaged in managing its subsidiary and that amounts to economic activity for this purpose."

Comment

The decision is an important one in the context of input VAT recovery and certainly indicates something of a return to the chain breaking effect of exempt supplies, at least in most scenarios. It does have the benefit of re-introducing an element of certainty to the attribution of input VAT, which, in this context, had become extremely complex, by reading the CJEU decision in SKF as having a much more limited effect that most commentators had considered to be the case.

In essence, the Court has concluded that the only thing that has changed since BLP is the removal of any assumption that might have been implicit in that case that inputs incurred in the context of a share sale are necessarily directly attributable to that share sale (so as to be irrecoverable); it is now accepted that those inputs may bear a direct and immediate link with the taxpayer's economic activity as a whole so as to be treated as overheads and recovered in proportion to taxable outputs forming part of that economic activity.

The decision will, of course, be disappointing to many businesses using an exempt share sale to raise finance for wider taxable activities. It remains to be seen exactly when costs incurred in connection with such a transaction may nevertheless not have a direct and immediate link with the exempt share transaction. Businesses in this position will need to carefully consider all the associated inputs and consider if and to what extent they may have a closer connection to the wider business than the immediate exempt transaction.