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Yesterday, the Supreme Court dismissed an appeal relating to the recoverability of input tax by a taxpayer incurred on the costs of the sale of a subsidiary. The Court of Appeal had overturned the decisions of the tax tribunals and denied the input tax claims by Hotel La Tour Ltd in relation to the share sale which it was undertaking in order to fund further hotel development. The Supreme Court appeal was heard earlier this year and the eagerly awaited judgment upholding the Court of Appeal’s decision marks an end to this long running dispute.
The Hotel La Tour issue
In a nutshell, the issue which the Tribunal and courts have had to grapple with is whether Hotel La Tour Ltd (“HLT”), the representative company of the Hotel La Tour Group, which carries on the taxable business of providing hotel accommodation, can recover input tax incurred in connection with a sale of shares in its subsidiary, Hotel La Tour Birmingham Ltd (“HLTB”).
HLT is a holding company which owned the share capital of HLTB. Both companies formed a VAT group with HLT as the representative member. HLTB owned and operated a hotel in Birmingham.
In 2015, HLT set out to develop a new hotel in Milton Keynes and decided to sell HLTB’s business and use the proceeds of the sale to part-fund the new Milton Keynes hotel. In 2017, HLT sold the shares in HLTB to a third party. The net amount received by HLT was £16m, less the costs of sale including the fees for professional services.
HLT had engaged various third parties to provide professional services to assist with the sale such as market research, buyer shortlisting, financial modelling and tax compliance. The services cost HLT £382,899.51 plus VAT of £76,822.95.
In filing its next VAT return, HLT sought repayment of the input tax incurred on the professional services. HMRC rejected the input tax claim on the basis that the VAT incurred by HLT in disposing of its subsidiary was directly attributable to the sale of shares, which was an exempt supply and so HLT was not entitled to repayment of that input tax.
Conversely, HLT’s position was that the input VAT incurred on professional fees should be considered as directly attributable to the wider taxable business activities, i.e. financing and constructing a new hotel.
(i) The First Tier Tribunal and Upper Tribunal
The matter was appealed to the First-Tier Tax Tribunal (“FTT”) which found in favour of HLT, determining that the share sale did not break the link between the input VAT incurred and the intended taxable business activities (development/running of the hotel). This was on the basis that the input VAT incurred on the professional fees was not considered to constitute a cost component of the sale of the shares. The shares were sold at open market value and the price was not affected by the professional costs that had been incurred.
The FTT concluded as follows:
"the Services were paid for out of the proceeds of sale, thus reducing the amount available for the taxable transactions and so being a cost of those taxable transactions. Further, for the reasons set out above, the objective purpose of incurring the costs of the Services was in order to raise the funds to pay for the downstream transactions."
HMRC appealed against the decision but the Upper Tribunal (“UT”) also found in favour of HLT, deciding that the input VAT should be treated as attributable to the ultimate economic purpose of selling the shares, namely, to fund future taxable activities. The input VAT was therefore recoverable.
(ii) The Court of Appeal
HMRC appealed again and was successful in the Court of Appeal which overturned the UT’s decision. The Court of Appeal found that HLT was prevented from recovering input tax which had a direct and immediate link with the exempt supply of shares in its subsidiary. The Court of Appeal ruled that the UT failed to apply the direct and immediate link test and erred in disregarding the existence of the exempt share sale.
The Court of Appeal said:
“I accept that the consequence of allowing this appeal is that HLT has "sticking" (ie irrecoverable) input tax despite being, in the ordinary course of its hotel business, a fully taxable trader. Whether that is the right or the wrong answer as a matter of tax policy is a question for those who design the tax, not for the courts and tribunals who apply the law as it is.”
(iii) The Supreme Court
HLT appealed the decision to the Supreme Court. Yesterday, we finally received the Court’s judgment in this long running litigation with the Supreme Court upholding the Court of Appeal’s judgment and thus dismissing the appeal of HLT.
The Supreme Court found that the direct and immediate link was between the cost of the professional fees and the sale of the shares in HLTB rather than the overall hotel business of HLT. Since that share sale was exempt, the VAT paid on the professional fees was not recoverable. The court considered HLT’s argument that the direct and immediate link test had been somewhat modified in its application to share sales to focus on the purpose of the transaction such that if the “exclusive reason” for the share sale is to fund the taxable business then it is directly and immediately linked with that business. The Supreme Court disagreed, noting that there had been no departure from earlier case law which rejects the need to focus on the purpose of raising the funds.
The Supreme Court also considered in much detail HLT’s argument that the recent case law of the CJEU establishes that, exempt transfers must be treated in the same way as out of scope transfers, to comply with the principle of fiscal neutrality. The result of this being that inputs incurred in making the share sale are to be treated as directly and immediately linked with the taxable person’s overall business and not to the share sale itself. The court ultimately rejected that argument concluding that the HLT’s submissions misinterpreted the CJEU case law.
Key takeaway
Businesses should give consideration to the methods used to raise funds which are intended for use in the furtherance of their taxable activities. The HLT principle suggests that the extent to which a business may be able to recover VAT incurred as part of the furtherance of certain business ventures related to their taxable activities depends upon the method used to raise funds for such ventures.
For example, if HLT had preferred to sell the hotel in Birmingham as a going concern, rather than seeking to sell the shares in its subsidiary, the result may have been that the transfer of a business as a going concern could be outside the scope of VAT. In such circumstances, assuming all the necessary requirements to be a transfer of a going concern were met, the VAT incurred in relation to the sale (including professional fees) may have been recoverable.
There may, of course, have been other reasons why HLT decided to structure the sale in the way that they did. However, it does provide pause for thought for other businesses when seeking to undertake similar transactions, and it is worth considering whether there are alternative ways to raise funds, each attracting different VAT treatments.