The Saints go marching in

The VAT Tribunal decision in Southampton Leisure Holdings plc, released on 24 June 2002 has dealt a blow to Customs & Excise's entrenc

hed policy of refusing to refund the VAT incurred by businesses on professional fees relating to a sale or issue of shares as part of a corporate acquisition or reorganisation. The decision will have ramifications for many businesses that undertake corporate finance transactions which involve the acquisition of shares in one company and, at the same time, the issue of shares or loan stock in another company to raise capital or fund the consideration for the purchase of the target.

The background

Southampton Leisure Holdings, the appellant company, issued shares to the shareholders of Southampton Football Club in consideration of the transfer to it by the club's shareholders of their shares in the club. After the acquisition of those shares, Southampton Leisure Holdings made management charges to the club.

Southampton Leisure Holdings recovered the input tax incurred on the various professional services provided to it in connection with the deal, on the basis that the services provided were used partly in making exempt supplies (the issue of shares) and partly in making taxable supplies (the management charges it made). As a fully taxable business it argued that it was able to recover the VAT incurred in full; this was because a proportion of the input tax incurred was attributable to taxable supplies under the provisions of Regulation 101(2)(d) of the VAT Regulations SI 1995 No 2518. Unsurprisingly, Customs took the view, as they always tend to do when shares are issued, that the professional services were used exclusively in making exempt supplies and thus that, under the provisions of Regulation 101(2)(c), no part of the input tax on the services supplied to the appellant company was attributable to taxable supplies.

The professional services provided to the appellant company on which VAT was incurred were fairly typical of the costs usually encountered in a corporate finance transaction. They included legal services, financial and commercial due diligence exercises carried out by reporting accountants, the services of a nominated adviser or sponsor to co-ordinate the transaction, the printing costs of the offer document, and the services of a public relations firm.

The tribunal considered the following three questions:

• Was there a direct and immediate link between the professional services supplied to the appellant company and the taxable supplies that it would ultimately make?
• As a matter of law, did the professional services supplied to the appellant have a direct and immediate link to its business as a whole (general 'overhead' costs) or was the link solely to the exempt supply of its own shares?
• If the services were found to have a direct and immediate link to an exempt supply, did all the services relate to the issue of the appellant's own shares?

Direct and immediate link

Citing Rompleman and Rompelman-Van-Deelen v Minister van Financien [1985] ECR 655, the appellant company argued that the professional costs incurred and the acquisition of the shares in Southampton Football Club were both preparatory acts to undertaking an economic activity, and were therefore a cost component of the subsequent taxable supplies it would make. In addition, there was a direct and immediate link between the supplies relating to the acquisition of the shares and the subsequent taxable supplies that company would make.

However, the tribunal dismissed these arguments, concluding that the recent decision of the European Court of Justice in Cibo Participations SA v Directeur regional des impots du Nord-Pas-de-Calais [2002] STC 980 made it clear that although the management of a subsidiary was an economic activity, there was no direct and immediate link between the services purchased by a holding company in connection with its acquisition of a subsidiary company and any subsequent taxable transaction.

The Tribunal therefore concluded that there was no direct and immediate link between the professional services supplied to the appellant company and the taxable supplies of management services made to Southampton Football Club.

General overhead costs

Customs argued that the European Court of Justice decision in BLP Group plc v Commissioners of Customs and Excise [1995] STC 424 was authority for the view that supplies made by merchant bankers, solicitors and accountants in connection with the issue of shares were directly attributable to an exempt supply and were not part of the general overheads of the business as a whole. The exempt supply of shares, Customs argued, was a 'chain-breaking' event, the effect of which was a direct link between the professional services incurred and the exempt supply of shares made by the appellant company. In addition, where services were supplied and used for an exempt transaction, the recipient of the services was not entitled to deduct input tax, even if the ultimate purpose of the transaction was the carrying out of a taxable transaction. It was not therefore possible to 'look through' the exempt supply of shares and examine the ultimate aim pursued by a taxable person.

The tribunal accepted that, as in the BLP Group case, if there had only been an issue of shares by the appellant company, the professional services would indeed have then related solely to the exempt supply of shares that was made. However, the key point, following the principles decided in Cibo, was that as the professional services were used partly for the exempt issue of shares and partly for the acquisition of shares in Southampton Football Club, the input tax incurred should be regarded as residual (general overhead) VAT incurred in connection with the appellant's business as a whole. This would have the effect of allowing it to recover a significant proportion of the VAT in question.

Costs relating to issue of shares

In answering the third question, whether all the services provided to the appellant company related to the issue of its own shares, the tribunal considered the High Court decision in RAP Group v Commissioners of Customs and Excise [1995] STC 424. That case also revolved around a company incurring the services of professional advisers in respect of a share for share transfer prior to making taxable supplies of management charges. The tribunal decided that, following the decision in the RAP Group case, the question was whether the professional costs incurred were used partly for an exempt transaction and partly for the general purposes of the business. The Cibo decision had already made it clear that if there was no direct and immediate link to exempt supplies, there was a link to the business as a whole.

Following the analysis of individual costs in the RAP Group decision, the tribunal concluded that all of the services incurred by the company that related both to the issue of shares and the acquisition of shares could be treated as general overhead VAT of the business and therefore were recoverable in full. Costs that related solely to the exempt issue of shares, such as the printing of the offer document and public relations advice, were held to be directly attributable to the exempt issue of shares and therefore the VAT on these costs was irrecoverable.

The right decision?

The decision in Southampton Leisure Holdings plc is important because it correctly distinguishes the circumstances in the transaction from the decision in BLP Group. Customs' policy of continually quoting BLP Group in the face of any costs relating to an issue or sale of shares is, I would suggest, based on a fundamental misunderstanding of that decision.

BLP Group argued that it sold its shares in a subsidiary to raise capital for its fully taxable business, but the court ruled that the ultimate purpose of the taxpayer was irrelevant. All of the input tax incurred was properly referable to the exempt sale of shares and the fact that the sale of shares generated cash for its taxable business did not allow it to attribute any VAT to the taxable business. However, in both RAP Group and now in Southampton Leisure Holdings plc, it is clear that, where there are two or more simultaneous transactions involving both the acquisition of shares in one company and the issue of shares in another company to raise capital or in consideration of the acquisition, the costs incurred that relate to both transactions may be treated as a general overhead and in the case of a fully taxable business, the VAT incurred can be recovered in full.

A wider impact

As the bulk of the VAT incurred by the appellant company in connection with this transaction was on lead adviser, accountancy and legal fees that related both to the issue of shares and the acquisition of shares, this was a significant victory for it. The printing costs associated with the offer document did not bear VAT, so in effect the company was only restricted in recovering the VAT on its public relations costs.

In most corporate finance transactions, there are likely to be very (sometimes extremely) large fees from advisers co-ordinating the transaction and undertaking due diligence exercises and legal work. These fees will invariably be subject to VAT, so the ability to recover the VAT on these particular costs would be a boon for companies undertaking similar corporate finance transactions to those in this latest case.

The principle set out in this decision could therefore have an important impact on many common corporate finance transactions.

For instance, in a management buy-out it is fairly typical for a special purpose vehicle (NewCo) to be formed to acquire the shares in a target company and at the same time to issue shares to the new management and other investors, such as a venture capitalist. Typically, the NewCo will then be VAT grouped with the target company on completion, or registered separately on the basis that it will make taxable management charges to its newly acquired subsidiary. In either case, following the Southampton Leisure Holdings plc decision, there is now a strong argument for recovery of the VAT incurred on the professional costs associated with all advice provided, other than that directly associated with the cost of issuing shares.

What next?

Many businesses, when reorganising their corporate structure, undertaking an acquisition or seeking additional finance to further their taxable activities, incur large amounts of VAT that Customs have steadfastly refused to allow them to recover because, as part of the overall transaction, there has been an issue or sale of shares. This has often been the case even when it has been clear that the share issue is but one of a number of simultaneous transactions and the professional services incurred did not solely relate to the share issue. The decision in BLP Group somewhat clouded Customs' vision.

Ever since the decision in RAP Group, rather like a ranting Gordon Strachan prowling along the touchline at a Southampton Football Club match, VAT specialists have been arguing with Customs that, in instances where there is a simultaneous issue and purchase of shares, the VAT incurred on most professional advisers' costs should be treated as a general business overhead, and not directly attributable to an exempt supply of shares. It will be interesting to see if Customs accept this argument in the light of the tribunal's decision in the present case, and the likely flurry of claims for unclaimed input VAT that will follow, or appeal the decision to the High Court. My hunch is that, in the likely event of an appeal to the High Court, as in RAP Group, Customs will lose. Perhaps then Customs may review their approach to such expenses, and VAT recovery in a corporate finance transaction can finally be put on a sensible footing.

Peter Williams, ATII, senior VAT manager with Tenon Group plc in the East Midlands, may be contacted at peter.williams@tenongroup.com.

Categories: Comment & Analysis