As you can imagine this is a complex area as the average deal generates a lot of costs. A bulk of these are around professional fees, which are indeed subject to VAT.
In aiming to be tax efficient, M&A deals also generally involve some sort of holding company structure. Holding companies are not, as a matter of course, entitled to recover VAT on costs and it’s important to note that HMRC has been recently targeting holding company structures in relation to VAT recovery.
In doing so it has been gaining an impressive success rate, so it’s important to be clear about the VAT position of different elements of the deal.
Different deal costs and the VAT implication
VAT incurred on deal fees can usually only be recovered on those costs directly attributable to taxable supplies going forward. With many M&A transactions often centred around the sale of shares (which is exempt from VAT), it means VAT incurred on associated costs is generally irrecoverable.
As we mentioned above deal costs, are often incurred not by a trading company but by a holding company or a Special Purchase Vehicle (SPV) company. This is set up for the acquisition of the business. In doing so, it becomes more difficult to prove there’s a direct connection from the holding company to a taxable business activity.
Restructuring and VAT qualification
Given the complexity of the VAT position and the sizeable costs generated in an average transaction, businesses often look at some restructuring of their corporate structure in preparation.
A couple of common examples here include:
1. Share-for-share exchanges
This is where old shares are exchanged for new ones. As this is a potential barter transaction, it may generate input tax issues for the entity and this would incur VAT on the deal’s fees.
2. A transfer of trade or of part of a business from one entity to another
This often happens when shareholders are looking to split the business activities across 2 or more entities. In this scenario a transfer of assets qualifies for VAT at 20%. The transfer of a trade or part of a business may, on the other hand, qualify as a VAT free transfer of going concern (TOGC).
The VAT recovery of associated costs then depends on the ongoing VAT position of the transferred business. If that is a VATable business, the associated input tax relating to the transfer should be recoverable. Saying that, it is very much dependent on how the deal is structured and its relating contractual agreements.
Shares and VAT
Holding shares or receiving dividends from a company does not generally qualify for VAT recovery.
Where, however, it can be proved there is genuine, economic business activity between the holding company and the target subsidiary company, VAT can be recovered. An example of this would be where the holding company provides genuine services to the subsidiaries, such as management services.
During and since the pandemic, businesses have looked to raise capital through a ‘Rights Issue’. This involves inviting existing shareholders to purchase additional new shares in the company. In doing so, it gives existing shareholders securities called rights.
With the rights, the shareholder can purchase new shares at a discount of the market price on a stated future date. The company is therefore giving shareholders a chance to increase their exposure to the stock at a discount price.
The sale of existing shares is exempt from VAT with a block on associated input tax. The issue of ‘new’ shares, on the other hand, is not deemed as a supply for VAT purposes and is also outside the scope. VAT on associated costs is then treated as part of the overheads of the business and recoverable according to the normal VAT recovery position of the business.
Invoicing implications and VAT
In its planning stage, and prior to any acquisition vehicle being set up, it is common for initial deal fees to be invoiced to the shareholders who are not VAT registered.
Also be mindful that HMRC is actively blocking VAT recovery where it believes there isn’t a supply of services to the company making the acquisition. Taking care in the creation of the new contracts when the new company is established, is strongly advised. It’s also important to ensure any invoices are addressed to the correct entity for VAT recovery.
VAT is a complex area when it comes to M&A deals and often isn’t factored in during the planning and due diligence phases. Handled incorrectly it can result in sizeable additional costs for the deal and stakeholders. It is therefore important to consult with VAT specialists as early on in the process as possible. They’ll be able to advise on the right structuring purposes and ensure VAT can be claimed back on the costs that qualify.
Specific advice should be obtained before taking action, or refraining from taking action, in relation to this summary.
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