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Markel Tax

15 Sep 2020

Business consolidation and VAT risk: buying a business

The economy has been in tumult for much of 2020 and it is only to be expected that there will be some consolidation in several industries. These usually involve complex deals and the VAT is often overlooked.

However, the VAT risk is usually significant and no taxpayer wants to be left with a VAT bill which dwarfs the projected benefits from the deal. 

The VAT issues to consider will depend upon the role of the taxpayer in the deal. The vendor’s VAT risks are different from the purchaser’s VAT risks, which are different again when a management buy-out occurs. We will discuss the different VAT risks from different viewpoints in a series of articles.  In this article, we consider a purchaser taking over another business. 

Buying assets

One approach to buying a business is to acquire the assets of a business.  

The purchase of a business’ assets will invoke the VAT rules for the transfer of a going concern (TOGC). There are several benefits to securing TOGC status, as the VAT charge is removed from the deal. This will give the purchaser a cash flow advantage, making funding easier for the purchaser to secure. It will also remove the risk of not being able to recover the VAT charged: HMRC has four years in which to challenge VAT on purchases which a purchaser has recovered. In addition to these benefits, where part of the assets purchased is property, an absolute saving can be achieved on SDLT.  

TOGC status is often worth securing, but they can be fragile as there are a number of criteria to fulfil and a purchaser can easily lose the benefits, resulting in adverse VAT and SDLT implications. Care should be exercised when pursuing TOGC status. 

Buying shares

Another way to purchase a business is to acquire shares in a limited company. This is not always possible and in any case the different nature of the purchase results in different VAT risks to be managed. A significant concern would be losing the ability to recover VAT on costs where there has been insufficient forethought at the outset. 

The acquirer should ensure that the agreement meets their requirement to reclaim any VAT which may be chargeable in the future, as appropriate, in the event that the transaction is found, at a later date, to be subject to VAT, e.g. issue of an invoice, payment terms etc. 

Conversely, if tax is charged because it is thought that there is a standard-rated supply but, in the event, it is found that the transaction is outside the scope of VAT, the supplier will still have to account for the tax but the buyer will not be able to treat the tax paid as input tax. The correct course of action is for the buyer to seek a refund of the incorrectly-paid VAT from the supplier who should reduce his own output tax liability via the issue of a credit note. Any VAT correctly charged on the supply will be fully creditable if the supply on which it is charged is to be used by the recipient in making a taxable supply. Input tax will not be creditable at all if the supply on which it is charged is to be used in making an exempt supply or in carrying on an activity other than the making of taxable supplies. Some input tax, however, will not be directly attributable in any such way (typically input tax on general business overheads). How much non-directly attributable input tax is creditable depends, in general, on the relative values of the person's taxable and exempt supplies and on the nature of his business activities as a whole. In some cases, all such input tax may be recoverable; in others, only a small proportion or none at all.

In the BAA case [2013] EWCA Civ 112, the Court of Appeal decided that the purchaser was not entitled to recover the VAT incurred on the costs of acquisition because at the time the costs were incurred there was no economic activity for VAT purposes and no direct and immediate link between the services received by the purchaser and any supplies later made by the purchaser to the acquired business. The importance of establishing a qualifying intention at an early stage and securely linking costs to this intention is central to the planning a purchaser should be undertaking. 

The BAA decision has been supported repeatedly in the courts in various different scenarios, such as mining industry cases (e.g. Upper Tribunal: Norseman Gold [2016] UKUT 69 (TCC)) where judges have found that what was intended, at the time costs were incurred, did not amount to a qualifying economic activity, resulting in VAT on costs not being recovered. It is likely that the court decisions would have been different if the circumstances argued by the taxpayer had been more certain and definite, which presents a planning opportunity to holdings companies looking to secure recovery of the VAT on their costs. 

The acquisition of a business via the shares in the company requires careful planning at an early stage and it is often worth considering purchasing the assets instead (see above).

Due Diligence

Whenever a business is acquired, there is a risk that a VAT liability will be acquired with it. As part of the due diligence on the vendor, the purchaser should also be checking for past VAT risks. These VAT risks come in various forms, such as compliance issues and existing default surcharge periods, applying an incorrect rate of VAT to sales, relying on HMRC rulings which the acquirer cannot rely on, omitting Capital Goods Scheme calculations, failing to repay to HMRC the VAT on bad debts, and so on. 

Some of these VAT risks apply when shares are purchased and some apply when assets are purchased. Unexpectedly perhaps, a VAT liability can be transferred to the purchaser under TOGC rules when assets are acquired. 

Any VAT risks should be indemnified in the deal agreement, but as HMRC has four years to impose VAT liabilities and penalties on a purchaser, it is advisable to adjust the purchase price at the outset to reflect known VAT risks. 

Conclusion

It is important to give full and early consideration to the VAT risks when purchasing another business. The information from a VAT review of the business to be acquired will affect how negotiations are handled, what indemnities are stated in the deal agreement and even what form the purchase will take. There are also significant savings to be achieved in structuring a deal efficiently from a VAT perspective. 

For further information or VAT support in purchasing a business please contact Markel Tax on 0370 218 5278 and ask to speak with Kevin Hall.

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Tagged Value added tax (VAT) services COVID-19
Next article in series

15 Sep 2020

Incorporation and property – possible pitfalls