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A new company established by a consortium led by Ferrovial incurred considerable costs in its successful takeover of BAA in 2006. Last year, the company successfully persuaded the First-tier Tax Tribunal that VAT on its deal costs should be refunded, but HMRC has now won an appeal to the Upper Tribunal. Although BAA lost on the facts in its case, the decision provides some clues as to how the chances of recovering VAT on deal costs can be increased.

The appellant company was a UK bidco - Airport Development and Investment Limited (ADIL). Its takeover bid for BAA became unconditional in June 2006, and ADIL joined the BAA VAT group with effect from September 2006, changing its name to BAA Limited in 2008.  After the takeover, ADIL provided management services to the BAA group (including corporate governance and directors services) although it did not charge a fee for these services.

The First-tier Tribunal decided in January 2010 that the relevant deal costs (fees for an investment bank, solicitors, and other advisers) were mainly concerned with the takeover, but that acquiring the shares in BAA shares was not an end in itself, just the means by which ADIL made a large investment in UK airport infrastructure.  On that basis, the First-tier Tribunal held that the VAT was recoverable, because there was a sufficient "direct and immediate link" between the deal costs and the taxable supplies that would be made by the BAA group after the acquisition.

In the Upper Tribunal, ADIL repeated its argument that it had incurred the VAT in the course of an economic activity (acquiring of the shares in BAA, with a view to actively managing the BAA group as an investment) to which intended taxable supplies the relevant VAT can be attributed, so the VAT is recoverable.  Alternatively, it argued that it had incurred the VAT in the course of acts preparatory to making taxable supplies of management services, or preparatory to making the taxable supplies that it would be treated as making after it joined the BAA VAT group.

HMRC contended that that ADIL was a passive holding company.  It was not engaged in an economic activity when it incurred the costs: it was simply seeking to acquire some shares, and did not intend to make any taxable supplies. HMRC also argued that there was no link between the pre-acquisition deal costs and any taxable supply: there was no charge for the post-acquisition supply of management services, and there was no link between ADIL's deal costs and the taxable supplies that would be made by the BAA group after the acquisition.

The Upper Tribunal could see no reason to overturn the First-tier Tribunal's finding of fact that ADIL had an economic activity, because its purpose in acquiring the shares in BAA was not an end in itself but rather the first step of an investment, which involved management of the group after the acquisition. Even though BAA ultimately lost the case, this conclusion will be helpful for other taxpayers in similar circumstances.

However, the Upper Tribunal considered that there was no "direct and immediate link" between the deal costs and any taxable supplies made by ADIL. ADIL had not made any taxable supplies when it incurred the VAT (before the takeover completed) and it has only established an intention to make taxable supplies after the acquisition. The Upper Tribunal also concludes that ADIL was not assisted by the VAT grouping rules, or the Faxworld case. In other words, the deal costs could not be considered as the cost components of any taxable supplies that ADIL might make itself, or be treated as making.

Although ADIL lost on the facts of the case, parts of the Upper Tribunal's decision suggest that ADIL could have won the appeal if it had been able to demonstrate that it had already formed the intention to join the BAA VAT group before the acquisition was completed, or if it could show that it was going to make a charge for the management services it intended to supply after the acquisition.

This suggests that other taxpayers in similar circumstances can improve their VAT recovery position by documenting an intention to join the target VAT group - and/or to make and charge for taxable supplies of management services to it - after the acquisition.

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