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BAA Loses Appeal Against GBP 6.7M HMRC VAT Assessment
The decision offers some helpful insights for other businesses using a similar acquisition structure.
Taxand UK summarises the decision and concludes that it is important for investors to be clear about their intentions at the outset when they begin to incur costs in respect of an acquisition.
A consortium led by Ferrovial SA set up Airport Development and Investment Ltd (ADIL) in 2006 to bid for, and ultimately acquire, BAA. ADIL incurred VAT on corporate finance and legal advice that it took mainly from Macquarie Bank and Freshfields in the course of bidding. ADIL was successful and acquired BAA's share capital in June 2006.
Previous European case law established that a pure holding company cannot claim VAT on costs as it has no economic activity. For this reason ADIL joined the existing BAA VAT group in September 2006. As a member of the BAA VAT group, ADIL was considered part of the single BAA VAT group registration.
At the end of 2006, the BAA VAT group claimed ?6.7million VAT that ADIL had incurred through the bidding and acquisition process. The rationale for the claim was that ADIL's VAT costs were attributable to BAA's overall business now that it was part of the VAT group. And as BAA made sales that were mostly subject to VAT, by virtue of its airport operative activities, ADIL claimed it met all the criteria for claiming VAT on costs.
HMRC took a different view: they blocked BAA from claiming VAT on ADIL's costs because they saw no adequate link between the costs that ADIL had incurred in bidding for BAA and the sales that BAA made either before or after its acquisition. For VAT to be reclaimable there has to be a 'direct and immediate link' between the goods or services a business buys and what it sells.
BAA appealed to the First-tier Tribunal which allowed its appeal. HMRC appealed the decision to the Upper Tribunal which ruled in favour of the tax authorities. Now BAA has lost a further appeal to the Court of Appeal.
HMRC must be content that their success at the Court of Appeal may be more durable than their success at the Upper Tribunal. Both Tribunals agreed that ADIL was carrying on an economic activity by carrying out preparatory work. The Upper Tribunal sided with HMRC on the second point of there being no direct and immediate link between ADIL's costs and BAA's activities that would allow the VAT on those costs to be reclaimed.
Now Lord Justice Mummery has, in his Court of Appeal decision, decided that there was no evidence of ADIL carrying-on or intending to carry-on "economic activity" when it incurred the acquisition costs, nor a sufficient link between those costs and the group's activities.
Despite the dismissal of BAA's case at the Court of Appeal, we can draw some useful points from the decision:
Intending to manage the target is not enough - The Courts accepted that ADIL intended from the outset not only to buy the shares of BAA but also to provide strategic governance of the group. That was not enough to prove "economic activity" - or even an intention to perform an economic activity - at the time ADIL incurred VAT.
The importance of management charges - After the deal was complete, there was evidence that ADIL intended to charge BAA for its management services. There was no evidence of this intention before the deal was complete. In fact, despite its intention, ADIL made no charges to BAA before it joined the VAT group.
Joining the target VAT group - The Courts found no evidence that ADIL intended to join the BAA VAT group at the time it incurred VAT. It's not clear how the decision would have differed if BAA had been able to demonstrate such an intention. But it is an important factor that businesses should still consider and may assist them in demonstrating a right to recover VAT in a similar situation.
We will have to wait to find out if BAA intends to appeal this latest decision. For the time being it appears that a lack of clear and demonstrable evidence of its intentions at the outset of the takeover bid has proved to be costly for the airport operator so far.