It is understood that HMRC is once again reviewing the VAT recovery position of deal costs.
Historically this issue has been the subject of a series of legal challenges and resulted in the ECJ case Kretztechnik (C-645/03), which many thought had resolved much of the conflict in this area. In 2005, HMRC issued several Business Briefs which confirmed that the VAT incurred on the issue of new shares as part of a refinancing exercise was recoverable as an overhead of the business raising the finance. VAT incurred on the sale of existing shares (an exempt supply) was irrecoverable.
Following a direct tax review of the issue, HMRC are thought to be once again challenging VAT recovery in this area. The basis of their current challenge appears to be focussed on the timings and stages of a typical Corporate Finance (“CF”) deal. Normally, following the appointment of CF advisers and the completion of the due diligence work, a Newco is established fairly late in the process. This Newco is usually then included in a VAT group with the existing company and its subsidiaries. The VAT on costs incurred by Newco is then recovered in the first VAT return of the VAT group (subject to any partial exemption restrictions).
HMRC are once again challenging VAT recovery by Newco on the basis that the services provided by advisers cannot be supplied to Newco as this company did not legally exist at the time the engagement letters were agreed and signed. A further possible challenge relates to situations where the professional services are jointly supplied to Newco and the bank/investors.
Neither of these points are new or insurmountable. However, if you are considering a refinancing exercise which involves the issue of new or existing shares, you should not assume that all VAT on costs is recoverable. In view of the levels of professional fees charged for CF work, the VAT could be significant and impact on the cash flow models.
It is understood that there is a test case on this issue going to the VAT tribunal. Until this case is heard and the decision given, the current position appears to be once again uncertain.
Engagement letters should be drafted in the light of the above and consideration given to the VAT position at an early stage.
This looks set to become the next legal battleground in the ever increasing complex world of VAT!