One of the basic principles of the VAT system is that VAT on purchases (inputs) is recoverable if the purchases are consumed in making taxable supplies (outputs). Interpreting this principle is difficult in relation to many industries, including the following:-
- Businesses making exempt supplies (e.g. those involved in finance, insurance, health, education, property, sports, charities, etc.) need to understand when they can recover input VAT.
- Entities involved in restructuring (e.g. holding companies, share acquisitions, share issuing, etc.) might not have a taxable activity.
- Businesses which allow private use of business assets can have their ability to recover input VAT restricted.
In BAA Ltd v Revenue and Customs Commissioners ( EWCA Civ 112, published on 21 February 2013) the Court of Appeal considered two tests to help determine whether a taxpayer is entitled to claim input VAT:
- The taxpayer must be carrying on an economic activity, and
- There must be a direct and immediate link between the purchases (inputs) and the taxable supplies (outputs).
The taxpayer, Airport Development and Investments Ltd, was formed to purchase the shares in BAA Ltd as part of a take-over. The taxpayer claimed £6.7m of input VAT on professional fees. It justified this claim as follows.
- There was an economic activity of “the provision of strategic governance to the BAA group”.
- The purchases were directly and immediately linked to taxable supplies made by the VAT group as a whole and to the taxpayer’s intended supplies of management services.
The Court of Appeal ruled that the taxpayer had failed both tests:
- The Court drew a distinction between an act with economic consequences (i.e. acquiring shares in BAA Ltd) and an economic activity (for VAT purposes).
- The Court considered that the benefit of the services purchased by the taxpayer was too remote to be directly and immediately linked to the supplies made by the BAA VAT group as a whole.
The Court’s initial observation was that “there was no evidence of [the taxpayer] having an intention to make taxable supplies at the time when it received the supplies of taxable services or of [the taxpayer] having an intention prior to completion of the take-over to join the BAA VAT group”.
This is important. The implication is that the taxpayer might have been able to recover the input VAT (as part of business overheads) if it had satisfied these two tests. Careful VAT planning at the outset could have ensured that an economic activity was in place and sufficiently evidenced at the right time.
The tests explored in this case are not limited to holding companies making share acquisitions. They can be helpful in planning any scenario where input VAT is claimed. Consider, for example, a business applying for VAT registration and claiming input VAT on pre-registration expenses, or claiming input VAT in partial exemption computations, or anticipating private use of the purchased business asset. These tests can help such businesses determine when input VAT recovery is justified.
For further information on input VAT recovery when restructuring, or in any scenario, please contact the TaxDesk on 0845 4900 509 and ask for Kevin Hall.