VAT position of Special Purpose Vehicles

The recovery of VAT by holding companies is a well-known risk area, but the application of those principles to corporate structures that include multiple Special Purpose Vehicles (SPVs) also needs careful management.

We cover a case study that looks at these risks. This involves a group in the renewable energy sector, but it equally applies to corporate groups in any sector which set up a similar structure.

Background

In this case, the corporate group was structured so that a UK holding company held shares in multiple SPVs that operated renewable energy sites. A new SPV was set up for each new site and held the necessary assets and licences to operate the site. In some cases, the holding company disposed of the SPV once the necessary licences were in place. In other cases, the holding company constructed the renewable energy site which was then operated by the subsidiary.

This structure is very common in sectors where it is likely that there will be a disposal of individual sites/businesses at some point in the future. This is because it allows full flexibility to dispose of the shares in the SPV rather than having to sell part of the main business. If more than one site is to be sold, this can be achieved by selling several SPVs as a package.

VAT position of SPVs

The VAT position of the SPVs should be relatively straight forward. They are trading companies that own all the assets required to operate the renewable energy site and supply electricity. As a result they are likely to be making wholly taxable supplies and there should be no issue with their VAT recovery. However, it will be necessary to fully consider the specific position of each SPV to ensure that there are no VAT costs. For example, the SPV will likely have an interest in the land for the renewable energy site. If not all of the site is being used, sub-letting part could create unexpected VAT costs without appropriate consideration having been given to the VAT position.

VAT position of holding company

The position with the holding company is much more complex. Holding companies have long created VAT issues and there have been numerous legal cases that have considered how much of the VAT that they incur can be recovered. We have considered this previously here.

Issues can arise for holding companies throughout their lifecycle. This means that careful planning is required to remove unexpected VAT costs and continuing diligence to maintain the optimum position. This is the issue that arose when HMRC carried out a review of the holding company.

Economic activity

One of the most common challenges we see HMRC make is around whether a holding company is carrying out an economic activity and making supplies which carry the right to VAT recovery and this was raised by HMRC in this case.

Where a holding company passively holds the SPV’s shares it is not engaged in an economic activity and so is unable to recover any of the VAT that it incurs. For these purposes, economic activity can cover a range of activities and often is created via making a management charge to the subsidiary.

In this case, the holding company was not passive as it was involved in providing a range of services to the SPVs. Once the required licenses were in place, the renewable energy sites needed to be constructed and this was done by the holding company engaging appropriate subcontractors and providing construction services to the subsidiaries. This provided the required link to allow VAT recovery on these costs. However, it was necessary to demonstrate this to HMRC especially in respect of projects which were aborted after some initial costs had been incurred.

However, there were other costs incurred by the holding company which had no direct and immediate link to the taxable supplies being made. Whether these were recoverable had to be considered separately to the point on costs related to construction services.  

It is common in such situations for the holding company to have an agreement in place to provide management services to the SPVs. In this case, services were being provided by the holding company but there was no formal agreement which created a challenge in persuading HMRC that there was the required link between the input tax and the taxable supplies being made. The position would have been much simpler had there been an appropriate management services agreement in place although it should be noted that, in order to be effective, the provision of the management charges has to be genuine with substance and a commercial rationale.

Disposing of the subsidiary

From time to time, the holding company disposed of the shares in the SPVs. The sale of existing shares to a UK purchaser is an exempt supply and it has been commonly accepted that any VAT incurred on the sale costs was disallowed as exempt input tax (subject to the de minimis limit). This has been questioned in the recent case of Hotel La Tour which has been successful in both the First Tier and Upper Tribunals. The decision in Hotel La Tour allows recovery on the costs of disposing of the shares if the purpose of the disposal was to generate funds which were to be used for the purpose of making future taxable supplies.

In this case, the subsidiary was being sold to generate funds to build a new hotel which would be the recipient of management services from the holding company thereby creating a direct and immediate link between the costs incurred and future taxable supplies. It should be noted that, at the current time, HMRC are appealing this decision to the Court of Appeal so it is likely that it will be some time before a definitive position is reached. However, any businesses who are in a similar position should consider submitting a claim to HMRC to protect their position.

Partial exemption calculations

The holding company was unaware that, as a result of making exempt supplies when disposing of the shares in the SPVs, it had to restrict its input tax recovery. It therefore had to consider whether the standard partial exemption method gave a fair and reasonable result or if the holding company should apply for a Partial Exemption Special Method (PESM). We have considered this previously here.

Once a decision had been made to use the standard method, it was necessary to carry out partial exemption calculations going back four years in line with the statute of limitations in the UK. This initially involved direct attribution of the costs to taxable and exempt supplies with the residual input tax then being recovered under the standard method.

In summary

It is essential that all businesses fully consider the VAT implications of their transactions, but this is even more important when a holding company is involved. In this case, a routine HMRC audit unearthed a large number of issues which had to be resolved and resulted in considerable management time and expense having to be invested to minimise the amount of VAT that had to be repaid to HMRC.

The VAT position of all companies should be kept under regular review but especially for holding companies where careful planning will result in the VAT recovery being maximised.  When disposing of subsidiaries, it may be that irrecoverable VAT is incurred as the decision is made to dispose of shares as an exempt supply for reasons other than VAT. Identifying these costs in advance will ensure that there is awareness of the costs of disposal and the VAT returns submitted to HMRC will be correct thereby removing the risk of exposure to penalties and interest being incurred.

If you would like to discuss further, please contact Rob Janering or your usual Crowe contact.