VAT recovery on deal costs
Understanding VAT Recovery on Deal Costs: Navigating Complex Rules and Strategic Opportunities
VAT recovery on deal costs is one of the most challenging areas of VAT. The rules are complex, evolving, and heavily scrutinised by HMRC. Errors can result in irrecoverable VAT, higher transaction costs, and potential disputes.
Businesses undertaking acquisitions, restructurings, or disposals must carefully consider VAT treatment. The outcome often depends on:
The nature of the acquisition, and
The link between the costs incurred and the business’s taxable economic activities.
Key Legal Principles
1. Direct and Immediate Link
Under Article 168 of the Principal VAT Directive (2006/112/EC) and UK law (VATA 1994, s.24), input VAT is only recoverable if there is a direct and immediate link between the costs incurred and taxable supplies made by the business.
No recovery: Where costs relate solely to exempt activities, such as the purchase of shares for passive investment.
Potential recovery: Where costs are attributable to the wider taxable activities of the business.
2. HMRC’s Position
HMRC generally resists VAT recovery where the acquisition is seen as an investment transaction, arguing that input VAT is not linked to taxable outputs. Recovery is more likely where the deal is structured to extend existing taxable activities.
Landmark Case: Hotel La Tour Ltd v HMRC [2023] UKSC 16
The Supreme Court clarified the rules on VAT recovery for deal costs linked to exempt share sales:
Hotel La Tour sought to recover VAT on professional fees linked to the disposal of shares in a subsidiary.
The Court ruled against recovery because the costs were directly linked to the exempt share sale and not to the wider taxable business.
The decision emphasises that commercial rationale alone is not enough – there must be a clear VAT link to taxable supplies.
Opportunities for Recovery
VAT recovery may still be possible in specific scenarios:
Management Services Route: If the acquiring entity provides management services to the target and charges VAT, deal costs may be recoverable. To support this:
A formal management services agreement should be in place.
Professional advisers should contract with the acquiring entity directly.
Extension of Taxable Activities: If the acquisition expands the business’s existing taxable operations (e.g. purchasing a venue to run taxable hospitality services), recovery is more defensible.
Practical Steps for Businesses
Plan early: VAT treatment should be considered at the structuring stage of a transaction.
Document intentions: Keep clear records showing how the acquisition supports taxable activities.
Formalise arrangements: Management services agreements must be in place where VAT recovery is sought.
Engage advisers directly: Ensure supplier contracts name the acquiring/taxable entity, not just investors.
Key Takeaway
The Supreme Court’s decision in Hotel La Tour is a reminder that VAT recovery on deal costs is not automatic. Success depends on aligning deal rationale, contractual structure, and VAT rules. With careful planning, businesses can mitigate irrecoverable VAT and strengthen their position against HMRC challenge.