Gabelle Tax Analysis: Can companies recover VAT on pre-incorporation expenses?
Can companies recover VAT on pre-incorporation expenses? Surprisingly, the answer is often yes. This will be important for all newly-formed businesses and for holding companies, as they might be in a position to claim input VAT which they currently believe to be an irrecoverable cost.
Many businesses assume that, because the taxpayer does not exist on the date services are obtained, it makes no sense to claim input VAT on pre-incorporation purchases. Similarly, many groups assume that, because the parent is a holding company, it cannot register for VAT and claim input VAT.
These assumptions were overturned in Cloud Electronics Holdings Ltd v Revenue & Customs Commissioners ( UKFTT 699 (TC), released on 14 November 2012), which confirmed that in the right circumstances a holding company can claim input VAT on pre-incorporation purchases.
Facts of the case
Some officers of Cloud Electronics Ltd wanted to do a management buy-out. Cloud Electronics Holdings Ltd was formed on 29 February 2008 as a vehicle for this.
Before the holding company was incorporated, the management buy-out team sought advice from several consultants on whether the management buy-out was viable. The engagement letters with these consultants were signed by members of the management buy-out team in their own names.
The holding company then charged fees to Cloud Electronics Ltd for managing the company.
HMRC considered the definition of “input VAT” in Section 24(1) of the VAT Act 1994:
“Subject to the following provisions of this section, “input tax”, in relation to a taxable person, means the following tax, that is to say-
(a) VAT on the supply to him of any goods or services … being (in each case) goods or services used or to be used for the purposes of any business carried on by him.” [our underlining]
In short, for a holding company to claim input VAT from HMRC, the purchases must be supplied to that holding company and must be used for its own business purposes. HMRC did not believe either criterion had been met and argued that:
- The consultants’ services had been purchased by the management buy-out team, not the holding company; and
- The holding company had no business activities, as it did not manage Cloud Electronics Ltd, but merely looked after the debt related to purchasing the company’s shares.
To whom were the services supplied?
At first glance, it might seem obvious that the services were supplied to the management buy-out team which had signed the engagement letters and which had benefitted from the consultants’ advice even before the holding company existed.
However, the Tribunal investigated the engagement letters in more detail. It found that the holding company had derived a benefit from the services. In particular, “the Tribunal determines that the advice, from which the management buy-out team benefitted, was not advice whether to invest in Holdings … but rather advice on whether Holdings should invest in Cloud i.e. the advice being addressed to Holdings.”
The Tribunal also found other factors relevant:
- All the tax points of the consultants’ services fell after the date of incorporation of the holding company;
- All the consultants were aware that the holding company would be incorporated as a vehicle for the management buy-out; and
- The pre-incorporation engagement letters mentioned “Newco”, with some engagement letters being replaced by new ones with the holding company once it had been incorporated.
Although the holding company did not exist when the consultants were engaged, the Tribunal concluded that the consultants’ services had been supplied to the holding company.
Did the holding company have any business activities?
Holding companies do not generally have business activities, they just hold assets. As a result, holding companies cannot usually register for VAT or claim input VAT from HMRC. The Tribunal confirmed this by stating that “the mere acquisition of financial holdings” was not a business activity.
However, the Tribunal inferred from the scale of fees charged (over £450k) that the holding company also appeared to be “supplying substantial management services” to Cloud Electronics Ltd. In other words, alongside the passive “holding” role, the company was also making business supplies of management services.
In the absence of evidence to the contrary, the Tribunal concluded that the holding company did have a business activity and was entitled to claim input VAT on purchases procured before its incorporation by the management buy-out team.
This case illustrates how, under the right circumstances, pre-incorporation engagement letters can be signed by parties other than the company without preventing the company from claiming input VAT on those purchases. This could be a valuable decision for new businesses.
Furthermore, the Tribunal also demonstrates that a holding company can be regarded as supplying management services to its subsidiary, provided it charges substantial fees and there is no evidence to the contrary. This too could prove valuable to parent companies in group structures which incur input VAT on their costs.
Both these conclusions will come as a surprise to many businesses. It is always worth exploring the options for claiming input VAT, whether forming a new business or inserting a holding company into a group structure.