One of the more complicated issues in the world of VAT is the question of the entitlement to VAT recovery of certain holding companies and entities. A recent case in the UK First-tier Tribunal (the Tribunal) in Melford Capital General Partner Ltd v. HMRC [2020] UKFTT 6 (TC) addresses questions of VAT recoverability framed in the context of a corporate general partner of an English limited partnership. That corporate general partner (the Taxpayer) sought to recover VAT input tax on the costs incurred in setting up and operating an investment structure.
The Taxpayer was the general partner of an English limited partnership (the Fund). The Fund held as investments the shares in an Isle of Man holding company (HPH), which, in turn, held shares in a number of companies and special purpose vehicles (the SPVs), each of which held a separate underlying asset, such as a commercial real estate property. The shares in the Fund were owned entirely by a limited liability partnership (LLP), which provided (VAT standard-rated) advisory, property management and administrative services to the Fund. Each of the SPVs entered into a deed of adherence with the LLP, under which the LLP would provide services directly to each of the SPVs in return for a fee paid to the LLP.
Importantly, the LLP and the Fund were members of a VAT group (VAT Group A). HPH and the SPVs formed another VAT group (VAT Group B).
The point at issue was whether the VAT incurred on both the set-up costs of the structure (including the costs of attracting investors) and the operating costs of running the business (including fund operator costs and due diligence expenses on reviewing new investments) was fully deductible by the Taxpayer as input tax.
Turning to the relevant UK VAT legislation, a taxpayer may deduct "input tax" (broadly, VAT incurred on supplies to that taxpayer of goods or services) from the "output tax" charged on supplies made by that taxpayer and account to HMRC only for the difference, to the extent the input tax relates to supplies which are used for the purpose of any business carried on by that taxpayer, and the supplies made by that taxpayer are not exempt. However, where a VAT group is formed, transactions between members of the group are disregarded for VAT purposes and all supplies made to or by any member of the group are deemed to be made to and by a single taxable person, the representative member, who is responsible for completing and submitting a VAT return on behalf of the group.
The Taxpayer argued, essentially, that the complicated fund management and holding structure performed in the same way as a classic holding company/subsidiary structure, which immediately would be familiar to any corporate group director. VAT Group A (consisting of the Taxpayer and the LLP) was supplying a taxable services, being management services, to HPH and the SPVs, and was not making any exempt supplies for VAT purposes.
Cases such as Cibo Participations SA and MVM Magyar (both decided in the European Court) have established that VAT would be recoverable in full by a taxable holding company which was actively providing management services, for consideration, to its subsidiaries. By contrast, the mere acquisition and holding of shares in other companies does not amount to an economic activity following cases such as Polysar. The Taxpayer's counsel argued in Melford that the position was "directly equivalent to the traditional holding company/subsidiary relationship," identifying VAT Group A's provision of management advice to VAT Group B as the factor which best illustrated the equivalence.
HMRC, however, opposed this view. HMRC argued that the set-up costs were not recoverable because they related solely to investment activities, which do not constitute an economic activity within the meaning of the VAT rules.
What was fundamental to HMRC's argument was that it was "erroneous" to treat VAT Group A in the same way as a holding company. Unlike a holding company, the Fund was limited in what it could do – not least by the terms of the investment prospectus. Nor did the Fund operate as a normal holding company in making certain supplies of interest-bearing loans to the subsidiaries in VAT Group B. The investment activities performed by the Fund did not, by themselves, permit any VAT recovery, argued HMRC. The Fund performed mere investment activities, and the costs of VAT Group A were therefore components of the non-business, non-economic investment activity of the Fund; such costs therefore would not be recovered for VAT purposes.
The Judge at the First-tier Tribunal was, however, persuaded by the Taxpayer's arguments.
The Tribunal determined that, for the purposes of the UK's VAT rules, owing to the existence of VAT Group A, the Taxpayer was to be performing an economic activity. As a group member, the Taxpayer's individual actions were disregarded; those actions were treated as being performed by VAT Group A. The Tribunal found that the activities of VAT Group A (which included the LLC as well as the Taxpayer) were sufficient to constitute the VAT-able supply of management services for consideration, with such services being provided to VAT Group B.
Notwithstanding the complex fund structure, the Tribunal held that the activities of the Taxpayer (as part of VAT Group A), and the activities of the Fund on behalf of which the general partner acted, were fulfilling the role of holding company. The set-up costs were incurred for the purpose of subscribing for shares in or lending money to VAT Group B with the intention of providing VAT standard-rated advisory and management services to VAT Group B. There was therefore, the Tribunal concluded, a direct and immediate link between those set up and an economic activity carried out, which permitted VAT recovery. The operating costs were also fully recoverable by the Taxpayer, as they related to VAT Group B's economic activity.
While the subject of VAT recovery in the context of holding companies has been the subject of much VAT litigation, the application to these rules in the context of a fund investment structure is novel.
In addition, the treatment of the Taxpayer as a member of a VAT group appears to have been a key part of the Tribunal determination of the case. This appears to be contradictory to HMRC's practice in this area, which emphasizes that where a holding company joins a VAT group, this does not in itself change the position on the recovery of input VAT on costs incurred by that holding company. The HMRC practice appears to identify that a link would need to be traced through to taxable activities of group members, with no exceptions being made for group members not conducting economic activities. The comprehensiveness and accuracy of the published HMRC guidance in this area is likely to come under considerable scrutiny following the decision in Melford.
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