Going through a deal is an all consuming process. Understanding the business, carrying out the due diligence, working out what you are willing to pay and negotiating all the little details takes every ounce of your energy. Everything is focused on getting the deal over the line.
But what happens on Day 2? When you are back in the weeds, running the business?
In every deal that we advise on, the recovery of VAT on deal fees is a question we are asked. HMRC have spent many years, mostly successfully if you read the cases, challenging the recovery of VAT on deal fees and creating a significant additional cost to the transaction.
However, with a little thought, initial effort prior to the deal being signed, and crucially following through on these intentions, this VAT cost can be removed.
The key issue is that Bidco (in whatever guise) needs to have an “economic activity”. In most deals, a Newco will be established to carry out the deal, bear the costs, and become the holding company for the trading subsidiary. And if it has no economic activity of its own, it cannot recover any of the VAT on its costs.
HMRC’s guidance states that In order to be able to deduct VAT incurred on costs of acquiring shareholdings in subsidiaries the following conditions must be satisfied:
- the holding company making the claim must be the recipient of the supply
- the holding company must be undertaking economic activity for VAT purposes
- that economic activity must involve the making of taxable (VATable) supplies.
- If the holding company is VAT grouped with its subsidiaries, it makes taxable supplies or loans for which it earns interest and the loans support the making of taxable supplies by the VAT group.
The guidance then goes onto state that a holding company is undertaking economic activity for VAT purposes where it makes or intends to make supplies of management services for consideration, to its subsidiaries. It is important to note that the management services must be genuine and provided for consideration which is more than nominal.
Three steps therefore need to be taken before completion:
- A Management Services Agreement should be drafted covering off all the services to be provided by Holdco
- Ensuring that the Holdco is the recipient of the supply. HMRC consider that a holding company is the recipient of the supply where it has contracted for the supply, including by novation and it has made use of the supply, been invoiced and paid for the supply. Each supplier needs to be contacted, and if necessary assisted in ensuring that the correct paperwork is in place; and
- Holdco is VAT registered – if it isn’t, it will really struggle to get the VAT back from HMRC! This can be as part of a VAT group, or as a standalone registration, Either would work, but as a purist (or perhaps just old fashioned), I prefer a standalone registration. One word of caution though – if there are loans between Holdco and the Trading company, a VAT group is definitely the way to go.
All of this takes us up to the point of completion. However to steal a slogan from elsewhere, VAT is for life not just for Christmas, and we actually need to follow through on the details outlined above. The MSA needs to be followed, the services provided and payments made under it. If it is stuck in a drawer and never looked at again then it is just an expensive piece of typed paper.
When we see clients with problems on deal fees, it’s normally because they haven’t done what they said they would before the transaction completed.
The key phrase is “economic activity”. Activity means doing something active, and it is too late to start that activity only after HMRC start making enquiries. All the structuring up front will be for naught if we don’t actually do what it says on the tin.
