CJEU: holding companies can recover VAT on takeover costs in principle

The judgment by the Court of Justice of the European Union (CJEU) in two linked cases referred by the German courts could have significant implications for UK companies currently appealing cases relating to the VAT treatment of deal fees, as it was a "strong dismissal" of the UK's policy in recent years, according to VAT expert Rhys Pippard of Pinsent Masons, the law firm behind Out-Law.com.

The cases involved two German holding companies, Larentia + Minerva and Marenave.

The CJEU's judgment could also expand the 'grouping' of related taxable persons for VAT purposes to a wider range of entities, such as partnerships that are not limited liability partnerships. This was because the purpose of rules in the Sixth VAT Directive allowing member states to limit VAT group membership to, for example, limited companies was restricted to the prevention of tax evasion or avoidance, it said.

In its judgment, the court said that the rules had been developed "with a view to combating abuses such as, for example, the splitting-up of one undertaking among several taxable persons so that each might benefit from a special scheme, to ensure that member states would not be obliged to treat as taxable persons those whose 'independence' is purely a legal technicality".

"It is ... for the referring court to determine whether the exclusion of entities lacking legal personality from the benefit of the VAT group scheme, as provided for in the national law applicable to the cases in the main proceedings, constitutes a measure which is necessary and appropriate for attaining objectives of that kind which seek to prevent abusive practices or behaviour or to combat tax evasion or tax avoidance," it said.

In the cases in dispute, the CJEU had been asked to consider both whether limited partnerships, acting as holding companies, were entitled to recover VAT on acquisition costs; and whether partnerships were eligible to join a VAT group registration. EU law allows member states to regard companies that are "closely bound to one another by financial, economic and organisational links" as a single entity for VAT purposes.

In its judgment, the CJEU said that VAT could only be deducted in relation to expenditure on "economic activities". It said that a holding company "whose sole purpose is to acquire shares in other undertakings and which does not involve itself directly or indirectly in the management of those undertakings" was not a taxable person, and therefore did not have the right to recover VAT. However this was not the case where, as in these cases, the holding was "accompanied by direct or indirect involvement in the management of the companies in which the holding has been acquired".

"The involvement of a holding company in the management of companies in which it has acquired a shareholding constitutes an economic activity within the meaning of [the Sixth VAT Directive] where it entails carrying out transactions which are subject to VAT by virtue of [that directive], such as the supply by a holding company to its subsidiaries of administrative, financial, commercial and technical services," the CJEU said.

On acquisition costs generally, the CJEU said that a taxable person had "a right to deduct even where there is no direct and immediate link between a particular input transaction and an output transaction or transactions giving rise to the right to deduct, where the costs of the services in question are part of his general costs and are, as such, components of the price of the goods or services which he supplies".

"Such costs do have a direct and immediate link with the taxable person's economic activity as a whole," the court said.

"In those circumstances ... the expenditure connected with the acquisition of shareholdings in subsidiaries incurred by a holding company which involves itself in their management and which, on that basis, carries out an economic activity ... must be regarded as attributed to that company's economic activity and the VAT paid on that expenditure gives rise to the right to full deduction," it said.

Rhys Pippard said that the judgment would "significantly" assist UK companies currently challenging HM Revenue and Customs (HMRC) decisions in relation to deal fees. However, it would not have an immediate impact on partnerships prevented from joining VAT groupings by the UK's existing rules, he said.

"The CJEU found that the VAT grouping rules do not have direct effect - so the provision cannot be immediately invoked by an individual before a national or European court where a member state's national law is incompatible with the directive on these points," he said. "Therefore, while the ongoing deal fees litigation should be helped significantly, expanding our VAT grouping regime will require a report to the Commission and infringement proceedings against the state."

In September 2014, HMRC published new guidance setting out the circumstances in which holding companies may recover VAT. At the time, it said that the guidance was subject to revision following the publication of the CJEU's judgments in the German cases.