VAT, management services and valuations

The FTT has released a lengthy decision on the correct approach to applying the "open market value" provisions in VATA 1994 Schedule 6 to intra-group supplies of management services: Jupiter Asset Management Group Limited v HMRC [2021] UKFTT 96. The decision considers in detail the correct approach to determining the open market value of a supply based on the supplier's costs, where there is no comparable unrelated-party transaction.

The decision also comments on the ability of a holding company to recover input VAT generally - confirming the view that it is not necessary to allocate residual input VAT between a holding company's taxable activities of providing management to its subsidiaries and the mere holding of shares in those subsidiaries.

Background

The case concerns the Jupiter Asset Management Group which was made up of a number of companies. In particular, the group was split into two separate VAT groups, JIM and JAM. The JAM group provided management services to members of the JIM group and sought to recover input VAT in relation to the provision of those services. This included residual input VAT in relation to costs incurred in relation to carrying out an IPO.  On investigation, HMRC rejected the claim on the basis that the input VAT was used to carry out non-economic activities. However, HMRC also issued a notice under paragraph 1 of VATA 1994 Schedule 6 requiring an open market valuation in relation to the management supplies.

Input VAT

The FTT rejected HMRC's argument that the input VAT incurred by the JAM group was not attributable to its supplies of management services to the JIM group. In particular, HMRC had argued that it was necessary for the taxpayer to show a direct and immediate link between the inputs and its taxable activities, and so far as general overhead costs were concerned, it was insufficient merely to show that the taxable person carried on only an economic activity.  Instead, the taxable person had positively to show that there was a direct and immediate link between the relevant costs and that activity.

The FTT rejected that contention. The FTT considered that the case law of the CJEU demonstrates that such a direct and immediate link is automatically deemed to exist in the case of the general overhead costs of a holding company which does not carry on any non-economic activity and does not make any exempt supplies. In other words, in order to recover the input tax in question, the holding company need merely show that it does not carry on any non-economic activity or make any exempt supplies.

The FTT accepted that this conclusion did involve some "oddity", in that "were the holding company to hold shares in subsidiaries without making any supplies of management services to those subsidiaries, then the holding company would fall to be regarded as carrying on a non-economic activity, with a consequent adverse impact on the recoverability of the input tax attributable to the holding company's general overhead costs". Logically, therefore, the FTT accepted that where a holding company is both holding shares in its subsidiaries and making supplies of management services to those subsidiaries, the holding company ought to be treated as carrying on two activities - the non-economic activity of holding shares in its subsidiaries and the economic activity of making supplies of management services to those subsidiaries - and accordingly, analysed in that way, the holding company would not be able to recover all of the input tax attributable to its general overhead costs. "However, the CJEU has held that the mere fact that the holding company supplies management services to its subsidiaries allows the non-economic activity of holding shares in the subsidiaries to which the management services are being supplied to be disregarded. That seems like a slightly surprising conclusion but we believe that that is approach which the CJEU has adopted".

Output VAT

The second question concerned the correct level of output VAT that should have been accounted for by the JAM group following the issue of a notice by HMRC under Schedule 6 paragraph 1. The FTT noted that "open market value" for these purposes is defined in VATA 1994 s.19(5) as "the amount that would fall to be taken as its value...if the supply were for such consideration in money as would be payable by a person standing in no such relationship with any person as would affect that consideration". In addition, open market value is also defined in Article 72 of the Principal VAT Directive, which contains two paragraphs. The first refers to the "full amount that, in order to obtain the goods or services in question at that time, a customer at the same marketing stage at which the supply of goods or services takes place, would have to pay, under conditions of fair competition, to a supplier at arm's length within the territory of the Member State in which the supply is subject to tax" and the second (where there is no comparable supply) defines open market value as "an amount that is not less than the full cost to the taxable person of providing the service".

Despite the different wording of s.19(5) and the PVD, the FTT concluded that there was no difference in application - albeit that the PVD was more prescriptive. The FTT also concluded that there could be no comparable transaction to the intra-group supply of management services in this case and therefore it was necessary to base the open market valuation on the second paragraph of Article 72 ie the full cost of providing the service.

Interestingly, the FTT was also faced with the argument that the open market valuation was essentially the same as applying the arm's length principle for transfer pricing purposes. Ultimately, the tribunal considered this point irrelevant (as it was necessary to determine the open market value based on the full cost), however it did discuss the issue in some detail, concluding (broadly) that open market value for VAT purposes could not be generally equated with the arm's length principle for transfer pricing purposes and the arm's length principle would not be an appropriate way to determine the open market value for VAT purposes.

As regards, the question of the "full cost" of providing the relevant management services, the FTT were faced with the question whether these should include all the costs on which the JAM group were able to recover it's input VAT on the basis of the provision of the management services (irrespective of whether they were actually used to provide those services). For example, the FTT noted that whilst it had concluded that all the residual input VAT on costs incurred by JAM could be recovered on the basis of the CJEU's approach, "there was no meaningful sense in which the JAM group could be said to have "used" the input tax-bearing costs associated with the IPO in making its supplies of the management services". Whilst those costs might well be deemed to be cost components of the economic activity with the result that the input tax attributable to those costs was recoverable, that did not mean that the costs were actually used in the course of that economic activity.

The tribunal noted that this was a difficult question to determine and had it been able to do so, it may have referred the matter to the CJEU. On the one hand, HMRC's approach had the benefit of treating the input tax and output tax sides of the JAM group in a consistent way. On the other hand, the taxpayer's approach had the benefit of according with the commercial reality. However, on balance, the FTT decided that the HMRC's view was to be preferred and that the costs to be included in the calculation of the open market value included all the costs on which the JAM group had recovered its input VAT. The open market value of the supplies of management services should include all of the costs the input tax in respect of which was recovered by the JAM group, since they had a direct and immediate link with the economic activity carried on by the JAM group and therefore formed part of the cost components of the supplies made in the course of that economic activity.

The tribunal also concluded that the "full cost" for the purposes of calculating the open market value was not, however, limited to those costs on which input VAT had been recovered. It was also necessary to consider whether the JAM group incurred costs in making the supplies which did not carry input tax. For example, to the extent that the JAM group used exempt or zero-rated supplies of goods or services to make the supplies of the management services, the costs attributable to those exempt or zero-rated supplies formed part of the full cost of making those supplies. In addition, it was necessary to take into account any other costs and these included, in this case, the reimbursement of directors' fees to the extent that they related to work carried out by the directors in providing the management services.

Comment

The decision covers a number of difficult issues in relation to the supply of management services within a group and the calculation of and recovery of VAT. The FTT was candid in regarding these issues as difficult and it would not be surprising to see the decision appealed in due course given the uncertainties in the application of the rules.

Despite the fact that the part of the decision dealing with input VAT recovery was the primary focus of the decision, it is very welcome to have the point reiterated that it is not necessary for a holding company to show a direct link between its residual input VAT and its management activities. It is sufficient if it does not have any non-economic activities to which the input VAT needs to be attributed and the mere holding of shares in those subsidiaries does not count as a non-economic activity for these purposes.