Tax Journal

Back to basics: VAT and groups of companies

20 January 2011

A number of conditions must be met before two or more corporate bodies can form a VAT group. If an entity wishes to join a VAT group but is regarded as a ‘specified body’ two further conditions must be met. There are many advantages to VAT grouping, particularly given the new penalty regime; however there are also a number of disadvantages so careful consideration must be given before deciding to join or form a VAT group. Whether holding company activities can be regarded as economic activity, with corresponding input VAT recovery, is a hot topic in view of BAA Ltd.

Sian Beusch explains the VAT rules concerning groups of companies

VAT advisers will recognise the common scenario whereby a non-VAT specialist colleague approaches them with the opening line ‘I have a company that is in a group....’ Of course the question is then whether the colleague is referring to a VAT group or a corporate group. In order for the correct VAT advice to be given it is essential that this question is asked and then answered correctly.

This article will firstly consider VAT grouping: the advantages and disadvantages of doing so along with the conditions which must be satisfied. The contentious question of holding companies and input VAT recovery will then be discussed. In many instances, the two overlap such as in the recent First-tier Tribunal case of BAA Ltd [2010] SFTD 587, which HMRC is appealing.

Who can join a VAT group?

Two or more entities can form a VAT group provided the following conditions are satisfied:

1. They are ‘bodies corporate’: Simply, a body corporate is a group of several persons who are treated as one person in law. This would include, inter alia, companies limited by shares or guarantee, private companies, unlimited companies and Limited Liability Partnerships. An individual cannot join a VAT group.

2. Each of the bodies corporate must have its principal place of business (head office) or a fixed establishment (eg, a branch) in the UK: The key point is that the entities must have a real and permanent trading presence in the UK with the necessary human and technical resources to carry on the activity in question. If an overseas company has a registered office in the UK this will not qualify unless the office has the necessary resources and is not just a brass plate presence.

3. The bodies corporate must satisfy the control test ie:

  • One of them controls the other(s);
  • One person (a body corporate or an individual) controls all of them; or
  • Two or more individuals carrying on a business in partnership control all of them.

A body corporate is regarded as controlling another body corporate in two sets of circumstances: it is the company’s holding company (within the meaning of the Companies Act 2006 eg, 51% voting rights etc) or it is empowered by statute to control the company.

An individual or individuals controls a body corporate if he/they would qualify as a holding company ie, if they hold the majority voting rights etc.

The controlling person does not have to be based in the UK.

4. They satisfy the anti-avoidance provisions: These complex provisions were introduced in 2004 (VAT (Groups: eligibility) Order, SI 2004/1931, art 2) to curtail the instances where the VAT grouping rules were manipulated to mitigate VAT costs for outsourcing arrangements ie, where a jointly owned entity was able to VAT group, even though it was ‘controlled’ by and for the benefit of a third party, saving large amounts of VAT for financial institutions, amongst others. Third parties, for these purposes, are persons outside the corporate group that includes the VAT group.

These anti-avoidance rules apply if a body corporate is a ‘specified body’. A body corporate is a specified body if it undertakes relevant activity. In short, it must be making positive-rated supplies to other VAT group members, which are not merely incidental to the body’s business activity, where the VAT group would not be entitled to recover the VAT on those supplies.

Another condition is that the corporate body wishes to join a VAT group which has a turnover exceeding, or is expected in the coming year to exceed, £10 million per annum, to include all supplies made outside the group, but not intra-group supplies.

Furthermore, a body corporate is a specified body if it is partly owned by a third party or the business activity is managed directly or indirectly by a third party, or if the body corporate is the sole general partner of a limited partnership. Finally, in general, the conditions do not apply if the body corporate controls all the other VAT group members or if the body corporate is a charity.

If the corporate body establishes that it is a specified body, two further conditions must be satisfied before it may VAT group: these are the ‘benefits condition’ and the ‘consolidated accounts condition’.

In short, these conditions exist to prevent a large proportion of profits from leaving the corporate body or VAT group to go to third parties.

As such, if 50% of the benefits (profits etc) of the relevant business activity accrue to one or more third parties, the corporate body fails this condition and is unable to group.

If this condition is satisfied, only the consolidated accounts condition remains.

This states that if the accounts prepared for the person controlling the group would be required by ‘generally accepted accounting practice’ (FA 2004 s 50(1)) to include the accounts of the specified body, and the consolidated accounts for the third party would not be required to include the body’s accounts, the condition is satisfied. In practice, this will exclude most joint venture companies from being eligible to VAT group.

HMRC refusal

A corporate body meeting the four conditions for VAT grouping discussed above can still have its application refused.

HMRC has 90 days in which to refuse the application if they believe this is necessary for the protection of the revenue.

HMRC has given some examples of when it believes it may be appropriate for an application to be refused, including poor compliance records or they suspect that grouping is required for a VAT avoidance scheme. Taxpayers can appeal to the First-tier Tribunal against HMRC’s refusal to allow grouping.

Furthermore, HMRC has powers under VATA 1994 Sch 9A para 1(1) to make written directions where certain detailed conditions are met. HMRC may direct that:

  • separately registered companies eligible to be treated as VAT group members are to be treated as such from a specified date;
  • a company within a group is removed from that group from a specified date; or
  • a supply within a VAT group initially treated as a disregarded supply is to be subjected to VAT.

However, HMRC must not issue a direction if satisfied that the ‘relevant event’ (a company has either joined or left a VAT group or a transaction has been entered into, any of which have given rise to VAT recovery that hitherto would not have been possible) was done for genuine commercial purposes.

Advantages of VAT grouping

  • VAT grouping avoids a VAT liability on intra-group supplies (see below);
  • Exempt supplies made by one company to another can be disregarded if both companies are VAT-grouped, resulting in the previous input VAT recovery restriction being removed;
  • A potential reduction in administrative costs as the group members submit one VAT return in the name of the group’s representative member. There will need to be an effective system in place to enable each group member to report its monthly/quarterly figures centrally to allow timely submission of the group’s VAT return to HMRC. The cut-off for each company will therefore be earlier than if they each submitted an individual return to HMRC and would require careful management;
  • Including an overseas company (provided they have a UK fixed establishment) in the VAT group can mean that no reverse charge arises on certain supplies from outside the UK. Where the recipient is partly exempt, this will reduce the irrecoverable VAT cost;
  • Where assets are hived up or down into a group company before that company is sold to a buyer outside the group, the VAT consequences of the intra-group transaction can be ignored; and
  • Sales invoices issued, or purchase invoices received, in the wrong company name would not require time-consuming amendment as supplies are treated as being made to, and by, the representative member of the VAT group.

The fact that VAT grouping avoids a VAT liability on intra-group supplies is clearly an important facility if the recipient cannot recover any or all the VAT it incurs.
It is also an aid to cash flow for fully taxable companies. If VAT staggers are not aligned, a company providing management services, for example, could pay over output VAT to HMRC, which the recipient company does not recover until some months later.

Looking at the corporate group as a whole this is not sensible cash flow planning.
Perhaps even more fundamental is the effect of the new penalty regime. In many cases, companies that believe they are fully compliant with their VAT obligations manage to overlook the fact that they are required to charge VAT on management services to a UK company, where the two are not VAT grouped.

This is a simple error but it is made extremely frequently. Under the new penalty regime for errors, the fact that the recipient company could recover the input tax in full is likely to be regarded as irrelevant.

It is also unlikely that the oversight will be treated as a mistake despite taking reasonable care. HMRC will most likely regard it as a careless error, which if disclosed voluntarily, may be free from penalty, provided the taxpayer co-operates fully with HMRC.

However, if HMRC discovers the underpayments during a visit, a ‘prompted’ penalty of a minimum of 15% of the potentially lost revenue is likely to be levied.

Although penalties in this category can be suspended, the taxpayer is obliged to comply with a number of stringent conditions for up to two years.

As it may be undesirable, or unachievable from a practical point of view to comply, VAT grouping would remove the danger that these supplies are overlooked from a VAT accounting point of view.

It is even possible to VAT group where no taxable supplies are made outside the group.

Disadvantages of VAT grouping

  • All members of the VAT group are jointly and severally liable for the VAT debts of any of the VAT group members (ie, the VAT debt due to HMRC from the representative member of the group). A former VAT group member is also liable for any VAT debts due during the period of its membership;
  • Under anti-avoidance provisions it is also possible for any members of a VAT group to be held liable for assessments relating to periods when they were not a member of the group. In addition, as a matter of course, assessments can be validly raised on the representative member of the VAT group for periods when it was not a member of the VAT group;
  • The partial exemption de minimis limit applies to the group as a whole. Consequently, there is more chance that the group will be partly exempt as the exempt input tax of all the group members must be combined when considering whether the threshold has been breached;
  • The £10,000 limit (or 1% of the Box 6 figure for the period of discovery, up to a limit of £50,000) for error correction applies to the group as a whole. Consequently, the net value of all errors made by the group members must be combined when determining whether an adjustment on the next VAT return is required or the submission of an error correction notification (formally known as a voluntary disclosure) to HMRC. It is nevertheless advisable to submit a notification to HMRC of the error even if it is adjustable on the VAT return. This will enable HMRC to assess whether it was an error despite taking reasonable care or a careless error (which can potentially be mitigated to zero anyway).
  • The cash accounting limit of £1,350,000 of taxable supplies in the next year applies to the group as a whole and not to the members individually;
  • The payment on account limit of £2 million (annual VAT liability) applies to the group as a whole and not to the members individually – the adverse cash flow effect of this provision should be seriously considered;
  • The purchase of the assets of a business as a going concern by a partly exempt VAT group result in an irrecoverable VAT charge (via a deemed self-supply);
  • An option to tax made by a VAT group member in relation to a property is binding upon all present and future members of the VAT group. This means that a body corporate bound by another member’s option to tax (known as a ‘relevant associate’) must charge VAT on any supplies it makes of the property, even after it has left the VAT group. Due attention must therefore be given where an opted property changes hands between VAT group members which is then supplied on to third parties.

Holding companies

Under UK rules a holding company may VAT group with its active trading subsidiaries, even where it does not itself undertake any taxable activity.

This will enable it to recover input VAT incurred on any group restructuring in line with the recovery position of the VAT group.

However, the availability of this facility is under threat following an announcement made by the European Commission (EC) on 20 November 2009.

The EC formally requested that 8 Member States, including the UK, amend their legislation in respect of VAT grouping. The EC began infringement proceedings on the basis that the UK allows non-taxable persons to be a member of a VAT group and this is believed to be non-compliant with European law.

The impact of this may be greatest during a restructuring exercise. If a holding company (which does not make management charges or carry on any business activity in its own right) incurs deal costs, it will not be able to recover the VAT on these costs if it is unable to join a VAT group with its trading subsidiaries. However, if a holding company does supply management services on a commercial basis VAT recovery should not be an issue.

The UK has responded to the EC stating that it will defend its current policy. The matter is therefore likely to be resolved by the European Court of Justice at some time in the future.

If the EC is successful in its contention, this would mean that a holding company would need to undertake taxable activity of its own in order to recover VAT incurred on a group restructuring (either as a separate registration or as part of a VAT group).

According to settled case law of the ECJ the acquisition and holding (and sale) of shares is not in itself an economic activity (EDM (C-77/01) [2004] All ER (D) 349 (Apr) and Investrand (C-435/05) [2008] STC 518.

However, where the holding is accompanied by direct involvement in the management of the company acquired in the form of administrative, accounting and IT services, this is to be regarded as economic activity (Polysar Investments Netherlands BV (C-60/90) [1993] STC 222, Cibo Participations (C-16/00) [2002] STC 460, and most recently restated in the cases of Kretztechnik (C-465/03) [2005] STC 1118 and AB SKF (C-29/08) [2010] STC 419).

In these circumstances VAT recovery should be possible, either via a separate registration for the holding company or via a VAT group registration. Clearly a separate registration is not desirable if the recipient company cannot recover the VAT charged.


This recent case tests the VAT recovery principles outlined above. The brief facts of the case are as follows:

  • An investment consortium led by the Spanish infrastructure group Ferrovial launched a takeover bid for BAA plc (BAA). The bid vehicle was a new company called Airport Development and Investments Ltd (ADIL). BAA became a wholly owned sub of ADIL.
  • ADIL joined the BAA VAT group. The representative member of the VAT group reclaimed the £6.7 million VAT incurred by ADIL on the deal fees. The fees were mainly from Macquarie Bank and Freshfields.
  • HMRC challenged the VAT deduction and issued an assessment. Their reasoning was that the costs incurred relate to the acquisition of the BAA business as a whole. The costs of ownership are investment costs that have been incurred by ADIL in raising finance to acquire the BAA group. There is no direct and immediate link between the supplies on which the VAT was incurred and any taxable supplies made (or to be made) by the BAA VAT group.

The Tribunal made the following findings of fact:

  • The purpose of ADIL was not only to acquire the BAA shares but also to provide high-level strategic governance of the ongoing group. This was ADIL’s first step in the long-term investment in the UK airport infrastructure. The debt facility raised by ADIL was specifically earmarked to fund BA’s £2 billion capital expenditure projects. There was therefore evidence of strategic input by ADIL.
  • There was no evidence before the Tribunal that an intention to make intra-group charges was formed prior to the completion of the takeover.
  • From the completion of the takeover in late June 06 it was intended that ADIL should become a member of the BAA VAT group – however there was no evidence of this intention before the Tribunal.
  • The services provided by Macquarie were mainly concerned with the takeover but the resulting work product did have continuing benefit beyond the takeover. Some benefits of the service carried on after the close of the takeover, either directly eg, the refinancing, or indirectly in that the BAA group was now open to the strategic management plans of ADIL.

The Tribunal concluded as follows:

  • Given its finding that the purpose of ADIL was not only to acquire the BAA shares but also to provide high-level strategic governance of the ongoing group, it concluded that ADIL did intend to carry on an economic activity (albeit it never made a taxable supply in its own right).
  • The performance of that economic activity was disregarded for VAT purposes as it was carried out within the BAA VAT group. ADIL and BAA are a single entity and, as such, ADIL should be entitled to take advantage of the economic activity of the BAA VAT group and therefore be regarded as a taxable person.
  • Applying the ECJ decision in Faxworld (C-137/02) [2005] STC 1192, ADIL was treated as having brought with it into the BAA VAT group the VAT incurred on deal costs. The recoverability of that VAT was dependent on the taxable outputs of the group. As such, ADIL was entitled to recover VAT in line with BAA’s partial exemption method.

The Judge also noted that his judgement is entirely consistent with HMRC’s published policy in its ‘Holding Companies’ section (Volume V1-13, s 15) and with HMCE Press Release number 59/93.

Although HMRC have appealed against this decision, it is very much in line with the ECJ’s judgment in AB SKF.

As such it is questionable whether HMRC will succeed in their appeal. Furthermore, the decision gives very useful guidance on what the Courts would regard as economic activity, which any company involved in a restructuring exercise would be wise to use as guidance in order to have the best possible chance of securing input VAT recovery on deal costs. 

Sian Beusch, Associate VAT Director, Baker Tilly’s National Tax group

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