SHARE ACQUISITIONS VAT

VAT Recovery on Professional Expenses

The Story so Far

The question of entitlement to VAT deductibility on expenses incurred in connection with transactions in shares, particularly the acquisition or disposal of subsidiaries, or shareholdings in subsidiaries, by means of purchase or sale of shares, has been a matter of debate between Revenue and practitioners for some time. It has recently become more pressing given the judgment of the European Court of Justice (ECJ) in Cibo Participations SA (Case C-16/00).

Under Irish VAT law, as under European law, transactions in shares and other securities are exempted activities. Consequently, there is no entitlement to VAT deductibility on any expenses incurred in connection with an acquisition or disposal of shares (apart from VAT on services deemed to be supplied outside the EU) (Section 12(1)(a) and (b)(ii) Value Added Tax Act, 1972).

The VAT treatment of expenses incurred in connection with transactions in shares was confirmed in discussions of the VAT Committee in Brussels following which an unanimous guideline was issued to the effect that

“VAT levied on costs incurred in connection with a transfer of shares was not deductible since those costs related to transactions that were exempted under Article 13.B(d) 5 of the Sixth VAT Directive”.

How the Polysar Judgement clarified the issue

Subsequent Judgements of the ECJ consistently held that

“a holding company whose sole purpose is to acquire holdings in other undertakings without involving itself directly or indirectly in the management of those undertakings without prejudice to its rights as a shareholder, does not have the status of taxable person and has no right to deduct tax under Article 17 of the Sixth VAT Directive” (Polysar Investments Netherlands BV-Case C-60/90 -Paragraph 17).

“However, it is otherwise where the holding is accompanied by direct or indirect involvement in the management of the companies in which the holding has been acquired without prejudice to the rights held by the holding company as shareholder” (Polysar -Paragraph 14).

Holding Companies and Supply of Management Services

The question of the distinction to be drawn between a holding company’s rights as shareholder and its involvement in management of its subsidiary was discussed in a number of the ECJ cases chiefly Polysar as follows, and was further developed in Floridienne SA & Berginvest SA (Case C-142/99) and in the Cibo case:-

“The national court has pointed out that Polysar’s activities are concerned solely with the holding of shares in subsidiary companies. It seems to me that such activities, which are undertaken in the exercise of shareholders’ rights do not constitute ‘economic activities’ within the meaning of the directive. The exercise of those rights includes, for instance, participation in the general meeting of the subsidiary’s shareholders, the exercise of the right to vote at the meeting and the possibility of influencing company policy thereby and, where appropriate, involvement in the decision appointing the company’s directors or officers and/or apportioning the subsidiary’s profits, as well as the receipt of any dividends declared by the subsidiary or the exercise of shareholders’ preferential rights or options”.

“Nor, in my view, is there any question of economic activities independently carried on within the meaning of Article 4(1) of the Sixth VAT Directive in the case of activities which the holding company, or persons acting in its name, carries out in its capacity as director or officer of a subsidiary company. A director or officer of the company does not act on his own behalf but only binds the (subsidiary) company whose instrument he is; in other words, where he acts in the exercise of his duties under the company instruments, there is no question of his acting ‘independently (Polysar - Paragraph 6 of Advocate General’s opinion).

In the Welthgrove BV case (C-102/00) in answer to the question as to whether the mere fact that a holding company involves itself in management of its subsidiary constitutes taxable activity, the Court replied that:

“the mere involvement of a holding company in the management of its subsidiaries without carrying out transactions subject to VAT under Article 2 of the Sixth VAT Directive cannot be regarded as an economic activity within the meaning of Article 4(2) of the Sixth VAT Directive" (Paragraph 17). As laid down in the Floridienne and Berginvest judgement direct or indirect involvement “in management of subsidiaries must be regarded as an economic activity within the meaning of Article 4(2) of the Sixth VAT Directive insofar as it entails carrying out transactions which are subject to VAT by virtue of Article 2 of that directive, such as the supply by Floridienne and Berginvest of administrative, accounting and information technology services to their subsidiaries” (Paragraph 19).

The Cibo Case

And so we come to the Cibo case. Cibo was a holding company involved in management of its subsidiaries. The crucial questions for consideration by the Court were:

• What are the criteria for establishing involvement by a holding company in its subsidiaries, i.e., is it provision of paid services, the running of a group of companies, or de facto management precluding independence on the part of a subsidiary, or some other factor?
  and
• If the receipt of dividends remains outside the scope of value added tax, what are the implications for the right to deduct?

The judgement recognised that there is no direct link between the services purchased by a holding company in connection with its acquisition of a shareholding in a subsidiary but that such costs are part of the taxable person’s general costs and therefore, they do have a direct link with the business as a whole:-

“Clearly, there is no direct and immediate link between the various services purchased by a holding company in connection with its acquisition of a shareholding in a subsidiary and any output transaction or transactions in respect of which VAT is deductible. The amount of VAT paid by the holding company on the expenditure incurred for those services does not directly burden the various cost components of its output transactions in respect of which VAT is deductible. That expenditure does not form part of the costs of the output transactions which use the services” (Paragraph 32).

“On the other hand, the costs of those services are part of the taxable person’s general costs and are, as such, cost components of an undertaking’s products. Such services therefore do, in principle have a direct and immediate link with the taxable person’s business as a whole (see BLP Group, paragraph 25, Midland Bank, paragraph 31, and Abbey National, paragraphs 35 and 36)” (Paragraph 33).

“In this connection, it is clear from the first paragraph of Article 17(5) of the Sixth VAT Directive that, where a taxable person uses goods and services in order to carry out both transactions in respect of which VAT is deductible and transactions in respect of which it is not, he may deduct only that proportion of the VAT which is attributable to the former” (Paragraph 34).

Review of Treatment where circumstances of CIBO are replicated

We have reviewed our VAT treatment of cases involving the acquisition by a holding company of a subsidiary to which it will provide management services “precluding independence on the part of a subsidiary”. Revenue understands this to mean that the judgement applies where the subsidiary is directly managed by the holding company and does not have its own independent management capability. Revenue will implement the judgment where the circumstances of the Cibo case are replicated.

A holding company involved in management of its subsidiaries has two activities:

• It has acquired a holding of shares in a company - a non-taxable activity
• It will supply management to the newly acquired subsidiary - a taxable activity.

The acquisition costs relate to both activities and an apportionment must be made to correctly reflect the extent to which the dual-use inputs are used for the purpose of its taxable (deductible) and non-taxable (non-deductible) activities (Section 12(4) Value Added Tax Act, 1972 and VAT (Apportionment) Regulations, 2000 (S.I. 254 of 2000) are relevant.

Attribution of Costs must distinguish between taxable and non-taxable activities

Clearly, as held by Advocate General Fennelly in the Floridienne case, a significant proportion of the inputs would relate to the non-taxable activities. For inputs relating to non-taxable transactions the Advocate General has stated that

“A taxable person may only deduct that proportion of its inputs which may properly be assigned to its economic activities. Every taxable person is obliged by Article 22(2) of the Sixth VAT Directive to keep accounts in sufficient detail to permit application of the value added tax and inspection by the tax authority, while Article 22(4) requires every table person to submit a return within an interval to be determined by each Member State, which may not exceed two months following the end of each tax period, although it may not exceed a year. The taxable person who seeks to exercise the right to deduct in circumstances where some of its VAT inputs may relate to non-taxable activities is obliged to establish, to the satisfaction of the relevant tax authorities, the proportion of those inputs which it claims are attributable to taxable transactions and thus capable of being deducted”.

Article 19(1) of the Sixth VAT Directive is, however, inapplicable. It can apply only in cases where taxable but exempt activities are mixed with taxable ones, since, otherwise, as in this case where the applicants only engage, in my opinion, in taxable and non-taxable activities, there is no difference between the numerator and the denominator of the fraction which that provision envisages. It is therefore for the national court, in the final instance, to determine the extent to which some of the deductible VAT inputs claimed by the applicants may in fact have related to the exercise, respectively, of its non-taxable shareholding activities and its intra-group lending activities and to exclude those inputs from the right of deduction claimed by them" (Paragraphs 38 and 39).

Apportionment of Costs

The next stop therefore is to arrive at a method for the apportionment of the costs between the management activity and the share acquisition activity. The normal method is (taxable turnover ÷ total turnover) ÷ inputs.

Where this method does not give an accurate reflection of the costs attributable to the taxable activity another method must be applied. Paragraph 5 of VAT (Apportionment) Regulations, 2000 (SI No. 254 of 2000) provides that the deductible amount shall be:

“(a) the proportion which –

• correctly reflects the extent to which the dual-use inputs are used for the purposes of that person’s deductible supplies or activities, and
• has due regard to the range of that person’s total supplies and activities”.

In the case of acquisition of shares in a subsidiary, the amount deductible must be determined on a case by case basis to reflect the above paragraph of the Regulations. In this regard Revenue will consider suggested methods of apportionment which reflect these requirements (see Revenue’s “Guide to Apportionment of Input Tax”).

VAT Deduction on Expenses Relating to Share Issues

Following publication by the Appeal Commissioners of a decision concerning a claim for recovery of professional fees arising from a proposed issue of shares enquiries have been received as to whether a change in Revenue practice will ensue. Revenue’s view continues to be that such expenditure does not relate to a taxable supply and is not deductible. Accordingly, there is no change in Revenue policy as regards recovery of VAT on expenses relating to an issue of shares.