UK Court of Appeal decision highlights scope of VAT recoverability

The Court of Appeal’s decision in HM Revenue and Customs (HMRC) v Hotel Law Tour Limited (46 pages / 321 KB) may be a concern to companies due to “the strong implication that costs associated with a fund-raising transaction should be treated as having a direct and immediate link with that transaction rather than looking at the downstream activity”, said Bryn Reynolds, a tax expert at Pinsent Masons.

The case involved Hotel La Tour Limited (HLTL), the holding company of a group that owns and operates luxury hotels. HLTL decided to sell one of its subsidiaries, which ran a hotel in Birmingham, to fund the development of a new hotel in Milton Keynes. It incurred professional fees for lawyers, accountants and marketing agents on the disposal of the shares in the subsidiary and sought to recover the VAT from these fees. HMRC refused the recovery.

Both the First Tier Tribunal (FTT) and Upper Tribunal (UT) found in favour of the HLTL, allowing it to recover its VAT. However, the Court of Appeal has overturned those decisions, concluding that the input VAT is irrecoverable.

Eloise Walker, corporate tax expert at Pinsent Masons, said: “When the Upper Tribunal came out with their decision last year, it was to gasps of surprise, and a flurry of protective claims from those keen to recover input tax on professional fees relating to fundraising transactions in the previous four years. Alas, those protective claims are now looking decidedly uncertain as the Court of Appeal has stamped firmly on the FTT and the UT’s mis-application of the appropriate case law tests and returned to the position favoured by HMRC a few years ago.”

The sale of shares by HLTL was an exempt supply for VAT purposes, whereas the HLTL group’s trading activities - the running of hotels - were taxable supplies for VAT purposes.

The general principle of VAT deduction is that VAT incurred by a company on goods or services that are used for the purposes of their taxable activities is deductible. VAT incurred on goods or services that are used for the purposes of their exempt activities is not deductible and becomes a cost to the company.

The Court of Appeal found that the FTT and UT had misdirected themselves when applying principles from previous cases to this one. It said that the FTT and UT had focused on whether the costs incurred were reflected in the price of the shares as a “cost component”, which was held to be incorrect.

Instead, the Court decided that the correct principle is that costs incurred in connection with, or related to, a share sale are not necessarily directly attributed to the share sale, and they may have a direct and immediate link to the general overheads of the company. It said that a two-stage test must be applied. First, the question is whether there is a direct and immediate link with the share sale. If so, the costs should be attributed to that share sale. It is only then necessary to consider whether there is a direct and immediate link with the general overheads if there is no such link to the share sale.

On this basis, the Court of Appeal decided that the inputs incurred by HTLT on marketing, legal and tax advice had an “objective economic link” to the exempt share sale because they were used to make the share sale. 

Walker said: “While the Court of Appeal did not go so far as to decide that such inputs had to be directly linked with the share sale in every case, so they might have a direct and immediate link to the general overheads of the company, and so be recoverable, if the fact pattern supported that, this will be scant comfort to taxpayers who have been fighting with HMRC on variations of this theme for years now.”

HLTL raised an alternative argument relating to the VAT grouping that existed between HLTL and the company that was sold. It argued that because supplies between members of a VAT group are disregarded for VAT purposes, HLTL’s holding of its subsidiary was not an economic activity, so the share sale was not an exempt supply but a supply outside the scope of VAT.

If the share sale was outside the scope of VAT, the VAT incurred could only be attributed to the general overheads.

The Court of Appeal did not accept this argument, saying that the statutory ability to disregard supplies between VAT group members did not extend as far as concluding that there was no economic activity.

A further appeal is expected. Ahead of this, “taxpayers who have recovered VAT will want to reconsider whether they have sufficient evidence to support that claim in light of this decision. Taxpayers who have not recovered input VAT will want to consider whether a protective claim is prudent given that, should permission to appeal be granted, the input VAT may be out of time by the time the appeal is disposed of”, said Reynolds.