The judgment of the Court of Appeal in BAA Limited v. The Commissioners for Her Majesty's Revenue and Customs was published on 21 February 2013. It was a bad result for the taxpayer.
The case is about whether input tax on fees incurred in connection with the acquisition of a company can be recovered. The case is particularly important in the context of acquisition companies that are unregistered for VAT when they incur VAT on transaction fees etc - eg new holding companies.
In the BAA case, a newco (ADIL) was formed to be the holding company of BAA Limited following a takeover of BAA plc, the airports operator, by the Ferrovial group. The takeover completed on 26 June 2006. ADIL was not VAT-registered when it incurred the VAT liability on fees (eg investment bank fees and lawyers' fees). On 22 September 2006 ADIL joined the BAA VAT group (ie the existing VAT group of the target company).
In order to recover input tax:
(1) ADIL must have been carrying on an economic activity at the relevant time; and
(2) there must have been a "direct and immediate" link between the supplies on which ADIL incurred input tax and outward taxable supplies of ADIL or the BAA VAT group (whether to specific outward taxable supplies, or to the taxable person's economic activity as a whole - for example in the case of overheads).
Merely acquiring and holding shares is not an economic activity. Something more is needed, for example where it is accompanied by direct or indirect involvement in the management of the target company.
ADIL argued that it had been preparing for, or was otherwise engaged in, fully taxable activities and that it should be able to recover its input tax once registered (either individually or as a member of a VAT group). ADIL's case was, essentially, that, once it had acquired BAA, it would control the strategic direction of the airports operator and that, by virtue of joining the BAA VAT group, the supplies received from its bankers and lawyers etc on the acquisition would have a direct and immediate link with the taxable supplies made by the airports operator in the course of its post-completion business. In other words, acquiring BAA was the first necessary step in providing strategic management and direction to the BAA group and that accordingly ADIL ought to be able to recover its associated input tax as a general overhead of the BAA VAT group.
The difficulty was that there were in point of fact no taxable supplies (or any clear evidence prior to the takeover of an intention to make any taxable supplies) from ADIL to BAA. ADIL did not provide for a fee any management services to the BAA group after completion of the takeover.
The Court of Appeal found that:
(1) The relevant date on which to ask the question as to recoverability was the date on which ADIL incurred the liability to VAT on the takeover fees. At that time, ADIL's only evident and proven intention was to take over BAA by acquiring its shares. There was no evidence of the making of taxable supplies or an intention on the relevant date to make taxable supplies. That finding was fatal for ADIL. It meant that ADIL was not carrying on an economic activity at the relevant time and its claim was therefore bound to fail.
(2) Even if there had been an economic activity, there was not the requisite direct and immediate link between the costs incurred and onward taxable supplies made by ADIL or the BAA VAT group. The taxable supplies received were only in connection with the takeover.
The judge concluded:
"At the relevant date [ADIL] simply existed and acted to acquire the shares in BAA without carrying on any economic activity that involved actual taxable supplies in its own right and without forming any intention, prior to the completion of the takeover, either to do so, or to join the BAA VAT group".
The case may be appealed to the Supreme Court, but it will not be easy to get leave, given the unanimous blow dealt by the Court of Appeal.
The BAA case involved around £6m of input tax. To a significant extent, it turned on its own particular facts, but there are other high value cases in the pipeline, so watch this space.
What does this mean?
Recovering VAT costs incurred in connection with a company takeover is not straightforward and should not be assumed.
Any buyer of a target company or group should check carefully the recoverability of VAT on the fees it incurs in the transaction. Where the buyer is already VAT-registered in its own right or as a member of an existing VAT group, that is likely to be helpful. The buyer should consider whether it will provide management or administrative or other services to the target company. If so, contemporaneous documentary evidence of that intention should be made and, after the takeover, the service arrangements should be implemented and carried out. The terms of engagement letters, the timing of issuing VAT invoices and the terms of intra-group service agreements will all be important factors, easily overlooked.
As the BAA case shows, it is perilously difficult to mitigate the VAT recovery position after the input tax has been incurred. It is much better to think about and get the VAT analysis clear at the outset.