The Supreme Court in Hotel La Tour has unanimously rejected the taxpayer’s appeal and determined that the input tax on deal fees connected with an exempt share sale is irrecoverable because of the direct and immediate link with the share sale.

Hotel La Tour (HLT) provided management services (for which it charged fees) to a wholly-owned subsidiary, Hotel La Tour Birmingham (HLTB), which operated a luxury hotel. When HLT decided to develop a new hotel in Milton Keynes it decided to sell HLTB and use the proceeds of sale to part-fund the new hotel. The HLTB share sale was exempt from VAT. To assist with the share sale, HLT incurred fees for marketing, legal and accountancy services and sought to recover the VAT on those fees. HLT argued that the share sale’s purpose was to raise funds for HLT’s wider business which included the making of taxable supplies and that the input tax on the advisers' fees should, therefore, be deductible.

The First-tier Tribunal (FTT) and Upper Tribunal (UT) had effectively accepted this argument – raising taxpayers’ and advisers’ hopes that input tax on deal fees should be recoverable where the share sale was for the purpose of funding taxable activity – but the Court of Appeal did not recognise such a rule and neither did the Supreme Court. 

Although the question of input tax recovery is of course fact-specific, taking account of all the circumstances surrounding the transactions at issue, the Supreme Court’s judgment provides a useful summary of the relevant case law and includes answers to some key general questions on recoverability of input tax.

Do costs have to be included in the price of the shares for the costs to be “directly and immediately” linked with the exempt share sale?

No. There is no reason under CJEU case law to examine whether professional fees were included in the calculation of the price charged for shares when this is not the case for other kinds of transaction. The fact that the negotiated price of the shares did not take into account the cost of the deal fees does not mean that the direct and immediate link is with the general business and not with the share sale. 

The Supreme Court noted that the language used by the CJEU of describing inputs as “cost components” or “components of the price” of the output is unhelpful and has given rise to problems but concluded it is clear from the CJEU case law that the “cost component” test does not depend on an examination of the pricing structure of the taxable person’s outputs. So long as the costs are in fact incurred for the purpose of taxable transactions the costs are, as such, “components” of the price of those transactions.

Has the CJEU erased the distinction between exempt share sales and “outside the scope” share sales?

No. The principle of fiscal neutrality cannot justify ignoring the way particular transactions are treated as exempt or outside the scope by the legislature. The taxpayer argued that the effect of the SKF case and the Supreme Court’s judgment in Frank Smart is that fiscal neutrality required that “the VAT incurred on fees for services acquired to assist with a share sale are directly and immediately linked with the general business of the taxable person regardless of whether the share sale is exempt or out of scope.” 

The Supreme Court agreed with the analysis of the Court of Appeal that the correct interpretation of the SKF case (and how it developed the CJEU case law) is that it accepted the possibility that inputs might have a direct and immediate link with the taxable person’s general business rather than with the share sale itself even if the share sale is one which is exempt rather than out of scope. The Supreme Court distinguished the Frank Smart case from the present one and concluded it could not be used to support the taxpayer's argument.

Has the “direct and immediate link” test been modified where the purpose of the share sale is to fund a taxable business?

No. The taxpayer argued successfully before the FTT and UT that where the purpose of a transaction is exclusively to fund the taxable economic activity, then it is directly and immediately linked with that business and not with the specific transaction. The Supreme Court found that the CJEU has not departed from earlier case law which firmly rejects the need to focus on the purpose of raising funds, noting that any such modification would cause confusion and would be open to manipulation. The only time that the taxable person’s intention in entering into the transaction is important is where the taxable activity has not yet commenced but the taxable person incurs inputs for the purpose of the future taxable activity and claims repayment of the VAT on that basis.

What is the effect of VAT grouping?

HLT argued that, as it was in a VAT group with HLTB, supplies between them should be ignored for all purposes. As this would mean the management services provided by HLT would be disregarded, HLT would not be carrying on an economic activity and so instead of being exempt, the share sale would be outside the scope of the VAT regime. This in turn would mean the fees had a direct and immediate link to the overall business and would be recoverable.

The Supreme Court held the Court of Appeal was correct to reject this argument: there is nothing in CJEU case law that supports the argument that supplies between a parent and subsidiary in a VAT group are to be ignored for all purposes. The purpose of the disregard provision in the UK’s VAT grouping rules is “to simplify and facilitate the collection of tax and not to confer exemption or relief from tax” (as Lord Nolan said in Thorn). HLT and HLTB retained their individual identities and economic activity was still taking place between them because HLT was engaged in managing its subsidiary for payment which amounts to economic activity for this purpose.

If you have any questions on VAT recovery in corporate transactions we are happy to advise.