VAT on takeover costs not recoverable by holding company, says Court of Appeal

The case concerned the 2006 takeover by the Spanish company Ferrovial SA of BAA plc (BAA). In June 2006 a newly formed company, Airport Development and Investments Limited (ADIL) acquired the shares in BAA. In September 2006 ADIL joined the BAA VAT Group and therefore became a taxable person with a VAT registration. BAA was the representative member of the VAT group and claimed recovery of the VAT input tax incurred by ADIL on the legal costs and other professional fees incurred prior to the acquisition of BAA and before joining the BAA VAT Group. It argued that the input tax incurred by ADIL should be offset against the output tax on the taxable supplies made by the BAA group.

In order for the VAT to be recoverable, ADIL had to be carrying on an 'economic activity' when it incurred the VAT and there had to be a 'direct and immediate' link between the VAT incurred by ADIL and the taxable supplies made by the BAA VAT group.

BAA argued that the supplies were made to ADIL in the course of an 'economic activity' carried on by it in preparation for acquisition of BAA. It argued that the VAT incurred by ADIL was part of the 'general overheads' of the BAA VAT Group and that there was a 'direct and immediate' link between the taxable supplies made to ADIL in connection with the take-over of BAA and the taxable supplies made by the BAA VAT Group. 

The First Tier Tribunal found in favour of BAA. However, the Upper Tribunal refused to allow the input tax recovery on the basis that, although it decided that ADIL was carrying on an economic activity, there was no 'direct and immediate' link between the supplies of professional services on which ADIL paid VAT and the taxable supplies on which BAA charged VAT. 

The Court of Appeal disagreed with both the First Tier Tribunal and the Upper Tribunal on the economic activity point. It decided that ADIL was not carrying on an economic activity at the time that it incurred the input VAT. 
Lord Justice Mummery said "ADIL's only evident and proven intention at that time was to take over BAA by acquiring the shares in it. Acquiring the BAA shares was an act which would have economic consequences, but that is not the same as carrying on an economic activity for VAT purposes: ADIL's activities at that time neither involved the making of, nor even the intention of making, taxable supplies of goods or services." 

He said "At the relevant date it 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 Court of Appeal agreed with the Upper Tribunal, that the First Tier Tribunal had been wrong to decide that there was a direct and immediate link between the input tax incurred by ADIL and the supplies made by BAA. Lord Justice Mummery said that the facts found by the First Tier Tribunal made it "impossible to describe or assess any link that existed at the relevant date between the VAT input and the VAT output as either 'direct' or 'immediate.'" 

"At the relevant date when ADIL incurred the liability to VAT on fees for professional and advisory services, the supplies to ADIL were only in connection with the act of taking over BAA. They were unconnected with any supply that ADIL intended at that date to make, let alone had actually made. BAA's outward supplies in the course of its economic activity were not connected at the relevant date with the supplies to ADIL on which input tax was incurred." said Lord Justice Mummery

He said " The link with 'the general overheads' of BAA was not direct and immediate, nor was the fact of any continuing benefit beyond the take-over."

Eloise Walker, a tax expert at Pinsent Masons, the law firm behind Out-law .com said. “This case can’t really be summed up better than by the judges themselves 'As may be gathered from the differences in expert legal opinion....the application of the law in this specialised area is somewhat unpredictable. It may take years to achieve finality in some cases.'" 

"Developments in this area are far from over, so watch this space, but the immediate practical impact is likely to be that those with accounting provisions holding money in reserve to pay HMRC if this test case was lost, will now be under pressure from their auditors and HMRC to release those provisions and cough up the cash.” Eloise Walker said.

The European Commission is currently arguing that the VAT rules in the UK, as well as Ireland, the Czech Republic, Denmark, Finland, Sweden and the Netherlands, do not comply with EU law because they allow holding companies to be members of VAT groups. The advocate general of the Court of Justice of the European Union (CJEU) issued an opinion in November 2012 saying that holding companies should be permitted to be members of VAT groups. The decision of the CJEU is awaited.