At present, the economic crisis brought on by the coronavirus pandemic is wreaking havoc on the UK M&A sector with many deals failing to get over the line. Some sectors, such as technology and healthcare, are looking to thrive while others are in a fight to survive.
The global financial crisis of 2008 demonstrated that a downturn in the market can bring opportunities for corporate buyouts and restructuring. Therefore, we should expect to see an increase in activity in UK and global mergers and acquisitions in the next 12-18 months, with the current crisis sparking opportunistic deals, particularly on smaller businesses that need to be rescued now. Meanwhile, other businesses are considering their restructuring opportunities.
Potential buyers should be aware that it is more important than ever to identify the risks associated with the target company’s business and performance, including the VAT implications of these deals, so a robust due diligence exercise is essential. VAT also plays an important part in the planning stage of these transactions, as it is common for a significant amount of VAT to be incurred on costs associated with acquiring, disposing or simply holding shares in companies.
HMRC generally takes an aggressive approach to the recovery of VAT on deal fees, so it is important to plan the structure of any corporate transaction in advance to maximise the recovery of VAT on associated costs.
The important point to recognise is that VAT incurred on deal fees can usually only be recovered where these costs are directly attributable to onward taxable supplies. However, corporate finance transactions are usually centred around the sale of shares, which is exempt from VAT, meaning that VAT incurred on associated costs is generally irrecoverable. Also, the deal costs are often incurred not by a trading company but by a holding company or an SPV company set up to acquire the target, making it more difficult to demonstrate a direct connection to a taxable business activity.
The act of simply holding shares or receiving dividends from the subsidiary is not enough to satisfy the rules for VAT recovery. However, there may be scope to recover VAT incurred on the acquisition where there is genuine, economic business activity between the holding company and the target subsidiary company, for example a management services agreement between the entities.
Many businesses may now take this opportunity to optimise their corporate structure. In restructuring, there may be a share-for-share exchange (old shares for new shares) in which case there is no monetary consideration but for VAT purposes, a potential barter transaction. This, in itself, may create input tax issues for the entity incurring VAT on deal fees.
In other types of restructuring, there could be a transfer of trade or of part of a business from one entity to another, for example where shareholders have opposing views on the direction of the business and may wish to split the business activities. Usually the transfer of assets would be subject to VAT at 20 per cent. However, depending on the structure of the transaction and contractual agreements in place, the transaction may be outside the scope of VAT as a transfer of a going concern.
Businesses looking to raise finance in the current crisis may also wish to consider undertaking a ‘Rights Issue’ with the purpose of raising capital for the business. Although the sale of shares is exempt from VAT with a block on associated input tax, the issue of ‘new’ shares is not a supply for VAT purposes and is outside the scope. This was subject to case law which now brings potential for VAT recovery on associated costs.
Finally, while the deal is in its planning stage and the acquisition vehicle has yet to be created, it is common for initial deal fees to be invoiced to the shareholders, who are not VAT registered. HMRC may try to block VAT recovery on the ground that the supply has not been made to the company making the acquisition. Therefore, it is important to novate contracts held with advisors to the new company as soon as it has been set up.
These issues have been the subject of complex case law in the UK and European courts and are a regular target for HMRC checks so it is important to take advice at an early stage on the VAT implications of mergers, acquisitions and restructuring.