Holding companies, management services and economic activities

Two recent decisions of the First Tier Tribunal emphasise the importance of properly documented agreements for recharging management services if a holding company is to be regarded as carrying on an economic activity: Norseman Gold plc v HMRC [2014] UKFTT 573 and African Consolidated Resources Plc v HMRC [2014] UKFTT 580.

The decisions show that only management services for which a fee is properly charged will give rise to an economic activity for a holding company. Where management services are supplied but the charge for those services is only set and levied at a later date, there will be no taxable supply made as those payments by the subsidiary will not amount to consideration for VAT purposes. In addition, where a holding company provides finance to its subsidiaries, that activity will only amount to to a taxable activity where it amounts to a commercial lending activity.

African Consolidated Resources case

African Consolidated Resources Plc (ACR) was a UK company with 7 employees and 3 directors and acted as the holding company of a number of subsidiaries involved in mining in Africa. ACR’s principal activity was to make loans to its subsidiaries and to provide management services to those subsidiaries.

The intra-group funding was in the form of loans at simple annual interest of 4%. Interest accrued was added to the loans and no interest payments had actually been made. The loans were, in principle, repayable on demand.

The management services were provided by one of the directors and billed by ACR at a fixed fee of £10,000. The fees were settled by increasing the outstanding loans from the subsidiaries and again no cash payments were made.

Dispute

ACR sought to register for VAT and HMRC refused this application on the basis that ACR was not carrying on an economic activity. HMRC accepted that lending activities could amount to an economic activity but only where a holding company is making loans to subsidiaries with a view to maximising the return on funds on a commercial basis. In this case, the loans were quasi-equity and not comparable to third party lending.

As regards management services, HMRC contended that there was no detailed evidence of what services had been provided by ACR to its subsidiaries, such that  ACR’s activities were a “speculative undertaking” and “not a serious undertaking earnestly pursued”. Moreover, even management services had been provided, the fixed payments could not be regarded as “consideration” for VAT purposes. Payments which are not directly linked to the value of services are not consideration and in this case it was admitted that the payments were fixed whilst the group as a whole was not earning any money but would be increased substantially if income did arise in the future.

Decision

The Tribunal did not agree with HMRC that lending to a subsidiary must be on a par with third party lending to amount to an economic activity. Intra-group lending could amount to an economic activity provided it was undertaken on a commercial basis with a view to making money. However, in this case, there were a number of aspects of the lending arrangements which were not consistent with the lending being at all commercial. These included the fact that the repayment terms were contingent, with no defined repayment conditions and there was no evidence that ACR considered on an ongoing basis the terms and rates of the lending. The loans were in reality in the nature of quasi-equity and did not amount to an economic activity.

The Tribunal did accept that management services were provided to subsidiaries and the lack of detailed documentation was not fatal to the claim. However, the Tribunal agreed with HMRC that the payment of £10,000 could not be regarded as consideration. The step-up nature of the fee to be charged did not indicate in itself that the fee was uncommercial, however, in this case, the fees had been charged retrospectively, based on the subsidiaries ability to pay rather than on the value of the services. There was a lack of any relationship between the charge and the value of the services provided. Therefore, there was the lack of the necessary link between the payment and the services. Indeed, in this case, there was intentionally no such link.

Norseman Gold case

Norseman was the AIM listed UK holding company of Australian gold mining companies. It incurred fees on the services of directors engaged via service companies, on accountancy and audit fees, fees incurred on raising finance, directors’ fees and Stock Exchange fees. Norseman provided finance to its operating subsidiaries on an interest fee basis. In addition, it registered for VAT with effect from 2006 on the basis that it intended to provide management services to its operating subsidiaries and recharge the cost of such services to its subsidiaries.

In practice, there was no formal agreement regarding management services to be provided and no formal agreement regarding payments from the subsidiaries for such services and, since the subsidiaries were not profit making, no charges were levied until April 2009 when Norseman invoiced and accounted for output VAT for one quarter’s fees. Further invoices were raised on a quarterly basis, though none were paid, since the subsidiaries did not return to profit.

HMRC denied claims for input VAT recovery on the basis that Norseman was not carrying on an economic activity and was not making any taxable supplies. HMRC contended that Norseman was not making supplies of management services and even if it was, there was only an intention to charge for those services if the subsidiaries were able to make payment and such an “optional” charge did not amount to consideration for VAT purposes.

Decision

The Tribunal has agreed with HMRC that the payment or charging for management services in this case did not amount to consideration for VAT purposes, such that Norseman was not carrying on an economic activity.

The Tribunal first considered whether Norseman was providing management services to its operating subsidiaries. The Tribunal was satisfied that the directors of Norseman played an active role in setting the strategy and direction of the subsidiaries. Therefore, the test set out in BAA case that there must be “direct or indirect involvement in the management of the companies in which the holding has been acquired” was met. Therefore, what Norseman provided to its subsidiaries was, in principle, capable of amounting to a taxable supply.

The difficulty for Norseman, noted by the Tribunal, was the absence of any agreement about payment for what was provided. Whilst the Tribunal did not go so far as to say that the payments in this case were voluntary, or that actual payment was a requirement as long as there is an obligation to pay, the failure by Norseman to determine the amount to be charged in advance was fatal to the case. In this case, there was at most a “rather vague intention to levy an unspecified charge at some undefined time in the future”. This failure to stipulate or agree any consideration “can lead only to the conclusion that there was no obligation to pay for the supplies at the time they were made”.

Accordingly, the Tribunal held that Norseman did not make any taxable supplies and could not recover the input VAT it had incurred.

As a side note, the Tribunal went onto to consider what would have been the situation had it found that Norseman did in fact carry on an economic activity. HMRC had pointed out the majority of the costs incurred by Norseman on which it had incurred input VAT related to its own position, in that they were incurred on statutory or Stock Exchange requirements or related to the raising of finance by Norseman. In this situation, the Tribunal accepted that the ECJ decision in Kretztechnik would be relevant and, rather than denying the input VAT on the basis that it was unrelated to the taxable activity of Norseman, that input VAT would have been properly regarded as residual (and so recoverable depending on the overall extent of Norseman’s taxable activities).

Comment

The decisions of the differently constituted Tribunals reinforces the fact that any agreement to provide management services must be properly documented and the agreement to pay for such services clearly set out in advance. Recharging such services at a later date and dependent on the subsidiaries ability to pay for such services will sever the connection between the service and the payment such that any payment made will not amount to consideration for VAT purposes and the services will not be regarded as an economic activity entitling the holding company to register for VAT.

However, it is interesting that in both cases the Tribunal did not place a high burden on showing the management services were actually provided. Therefore, where such services are properly documented and the fees for such services are set out in advance, obtaining registration as a holding company should not be onerous.

The decision of the Tribunal concerning the quasi-equity nature of the lending activities of ACR was to be expected on these facts. The loans were open-ended, interest was simply accrued and there was no evidence that any commercial considerations were taken into account from the holding company’s perspective.

The decisions are a reminder that HMRC will challenge the VAT registration of holding companies where there is not sufficient evidence of economic activity. Management services or lending on reasonably commercial terms can amount to an economic activity, but it will be necessary to properly document such services and ensure that payments made are clearly attributed pursuant to appropriate contractual documentation.

Update

The Upper Tribunal has upheld the decision in Norseman Gold v HMRC. For more details, see VAT recovery by holding companies: no consideration for management services.