Value Added Tax Concerns

In the final article of a series by Burges Salmon [see previous] looking at the sale of shares in private companies, NIGEL POPPLEWELL FTII discusses the VAT issues faced by the purchaser.

The VAT issues on an acquisition of shares are relatively straightforward (in theory at least). There are complexities (and secondary liabilities to be considered) if the shares are bought out of a VAT group. These liabilities are usually covered by due diligence supported by indemnities in the share sale agreement and a specific documenting régime dealing with the practicalities of degrouping. The position from a purchaser point of view is assisted by the case of Commissioners of Customs and Excise v Barclays Bank plc [2000] STC 665 which, simply stated, is authority for the proposition that once a company ceases to be eligible for membership (because, for example, its shares have been sold), VAT grouping automatically determines irrespective of whether an application for cessation of membership has been given to Customs. Degrouping does not therefore depend on notification but on the actual state of the group at any particular time.

Vendor and purchaser will both be concerned about VAT recovery on costs they have incurred on the share acquisition. The provision of legal services to vendor and purchaser will be standard rated unless the services can be brought within the ambit of note 5 to Group 4 of Schedule 9 to the VAT Act 1994 (intermediary services). This would be an extremely unusual role for a lawyer or an accountant, although less so for a merchant bank, to fulfil.

Given that the transfer of shares is exempt (item 6 of Group 5 of Schedule 9) input tax on services supplied exclusively on buying and selling the shares will be irrecoverable (Regulation 101(2)(c) of the VAT Regulations 1995 (SI 1995 No 2518).

Assets

With an asset sale, the position is considerably more complicated. The decision in Abbey National plc v Commissioners of Customs and Excise (Case C – 408/98) [2001] STC 297 has shed some doubt on Customs' current practice relating to the recovery of input tax on costs incurred when assets are bought and sold. However, the main issue which practitioners face is to decide whether the transaction is a transfer of a business as a going concern governed by section 49, VAT Act 1994 and Article 5 of the VAT (Special Provisions) Order 1995 (SI 1995 No 1268).

It is unusual in my experience for the status of a transaction to be the source of acrimony between advisers. It is in the interests of both parties to correctly categorise the transaction as a transfer of a going concern or otherwise. For the vendor, if it is wrongly categorised as such a transfer when in fact it is a taxable supply, he will be obliged to pay output tax to Customs which he has not got from the purchaser. While he will usually take an indemnity, that might not be worth the paper it is written on. Putting the VAT element into an escrow account pending a ruling from Customs is seldom done in practice. Normally parties are content to rely on an indemnity in the spirit of goodwill which characterises the negotiations for the deal.

From the purchaser's point of view, if it is wrongly categorised as a VATable supply when in fact it is a transfer of a going concern, the VAT he has paid to the vendor is not input tax in his hands, so he will get no recovery for it and want reimbursement from the vendor. Again, any obligation to repay given by the vendor may turn out to be worthless.

Given the fact that it is usually possible to determine with some certainty whether or not a transaction is a transfer of a going concern, the transfer of a going concern clauses can be settled amicably. Usually the transaction is treated as a transfer of a going concern, but there is an indemnity in favour of the vendor to recover the VAT if Customs decide that it is not. The important point is to make sure this indemnity is worth something, and, immediately after exchange of contracts, clients should seek a ruling from the VAT office dealing with the vendor's tax affairs as to the status of the transaction. Customs seem prepared to give such a ruling, and on the basis of assurances given by the purchaser in the document as to how they intend to operate the business once they have acquired it, a simple letter accompanied by a copy of the contract is usually sufficient to enable the ruling to be given. It is often the case that the letter is an agreed form document either at the time of the exchange of contracts or it is agreed between the advisers subsequently.

It is important to agree that the ruling of the relevant VAT office is conclusive, and to decide to which VAT office the application should be made. Since the output tax is the vendor's, it is usually the vendor's VAT office which makes the ruling. It is important to do this, since it is not unknown for vendor and purchaser VAT offices to give different opinions.

The advantage of bringing the matter early to Customs' attention is that if they decide that the matter is not a transfer of a going concern and the vendor has to call in the indemnity, it is more likely the purchaser has the funds to settle it. Waiting until a VAT control visit some time in the future, and a subsequent determination that a transaction is not a transfer of a going concern, might mean that the purchaser's indemnity is worthless.

Stamp duty

If VAT is payable on a transaction of property which is subject to stamp duty, stamp duty is charged on the VAT element. What is the situation with a transfer of a going concern which subsequently turns out to be VATable? Stamp Office practice is set out at paragraphs 4.472 and 4.473 of the Stamp Office Manual. The Stamp Office recognises that Customs 'have ceased their previous practice of providing advance clearance' in respect of transfers of going concerns, and recognise the difficulty this causes taxpayers in trying to determine the correct amount of stamp duty when the VAT status of a transaction is uncertain.

Stamp Office will, as a rule, accept transfer of a going concern treatment, if that is what the taxpayer wants, and charge stamp duty on the net amount. This is provided that the adviser has told the client that he will have to pay the extra duty if the transaction is subsequently judged to be VATable, and the client gives undertaking that the document will be returned to the Stamp Office in those circumstances, with the additional duty which must be paid on the VAT element.

This is another reason to go for a swift, post-transaction ruling for VAT purposes since, if the ruling can be obtained within 30 days, a copy can be sent to the Stamp Office and there is no need to involve the client in giving an undertaking.

Offshore execution

The problems that I have encountered in dealing with documents executed and kept offshore for stamp duty purposes in relation to a VAT indemnity, have been dealt with above. Seeking a swift ruling does not really assist here; it simply raises the problem of enforcement early on if, having received a ruling that it is not a transfer of a going concern, the vendors request for payment under indemnity is initially resisted!

Option to tax

For a business which includes real property, advisers must be aware of the impact of the option to tax. Broadly speaking there are two circumstances where this is relevant:

• if the business is a let property (property rental business);
• where the let property passes as part of transfer of a more extensive undertaking.

Property rental business

Appendix B of Customs Notice 700/9 sets out a number of circumstances where the transfer of property can constitute a transfer of a going concern where the property is let. It is interesting to note that paragraph 4 of appendix B shows that a property can still qualify as a property rental business (and thus probably an undertaking for section 76, Finance Act 1986 purposes) even if there is no tenant in place under a formal tenancy agreement. It is sufficient to have 'found a tenant but not actually entered into a lease agreement when you transfer the property to a third party (with the benefit of the prospective tenancy but before a lease has been signed)'. There must be a specific tenant. If so, and terms are concluded in principle, it can be a transfer of a going concern. If not, and tenants (in general) are being sought, then it is not.

Where property is a property rental business or it passes as part of other assets and the vendor has exercised the option, transfer of a going concern treatment will only be applied if the purchaser also opts and notifies Customs of his election 'no later than the relevant date'. This was the issue in Higher Education Statistics Agency v Commissioners of Customs and Excise [2000] STC 332. The relevant date is the date of grant. Where a deposit is paid under a property contract, the date of grant will be the date of contract if the deposit is held by the vendor's representative (usually solicitor) as agent for the vendor (rather than stakeholder). This is common in buying at auction. It is less common in a sale by private treaty.

Thus, if transfer of a going concern treatment is required, it is important that the purchaser elects and notifies Customs of the election on or before the contract date. It is perfectly permissible to opt and notify in respect of a property in which you have, at that time, no proprietary interest. The recommended procedure now when purchasing property rental business at auction, is to opt and notify against the whole of the auction catalogue prior to attending!

Sometimes this causes problems when purchasing into a newly formed special purpose vehicle company which is being set up to own a property where the transaction is to be rushed through and it is unlikely to be able to register the special purpose vehicle (let alone opt) with effect from the date of the transfer. In these circumstances, it is often difficult to obtain transfer of a going concern treatment simply because of the logistics of registering.

Sometimes the parties do not want transfer of a going concern treatment to apply. One way around this when transferring a property rental business on which the vendor has opted, is for the purchaser to opt but deliberately forget to notify before the relevant date. In these circumstances, transfer of a going concern treatment is unavailable.

Miscellaneous

If property is subject to the capital goods scheme, then paragraph 2.6 of VAT Notice 700/9 is relevant. The purchaser assumes the capital goods scheme history of the vendor. The vendor needs to be careful when transferring property (especially as part of a larger undertaking) as the capital goods scheme will claw back input tax already recovered if he fails to opt on the onward transfer.

The transfer of records provisions (section 49(1)(b), VAT Act 1994) pass the onus of keeping the records from the vendor to the purchaser. Where this is acceptable (the vendor may wish to keep them and make a direction to Customs for this to be the case), the purchaser will need to have access. Similarly, if the records do go to the purchaser, the vendor will need to have access. In either case it is normally dealt with by a clause in the documents enabling the non-recordkeeping party to inspect and copy at reasonable times and on reasonable notice.

Partially exempt VAT groups

Clause 4 of the Customs and Excise notice deals with partially exempt VAT groups. Solicitors tend not to investigate the VAT position of their purchasing client, often because they are neither interested nor are they sufficiently intimately acquainted with the VAT arrangements of their client so as to be able to give a view. However, in this area, it is important that they do check whether their purchaser client is part of a VAT group which has a partial exemption problem.

Where there is an acquisition into a partially exempt group, the representative member must treat the transfer as both a supply to it and a supply by it at the time of the transfer to it. Output tax will be payable in the circumstances, subject to certain conditions. This may come as something of a surprise to a client, and can usually be avoided by purchasing the undertaking into a specially formed company which is outside the group registration. It is an area therefore where a solicitor might feel he should enquire as to the VAT status of his client or certainly raise the issue in correspondence if only to deny responsibility.

Costs

The position of cost recovery on management buy-outs has recently been considered in the case of RAP Group plc v Commissioners of Customs and Excise [2000] STC 980 and warrants an article in its own right. For the professional adviser, it is important to identify, precisely, the services supplied and ensure that the relevant files are open for the different clients (the management buy-out team individually, the management buy-out vehicle, advice on funding rather than on the acquisition, etc.) and proper apportionment made.

For asset sales, Customs' position concerning the recovery of input tax incurred on professional fees relating to a transfer of a going concern has recently changed following the European Court of Justice decision in Abbey National plc.

Prior to this case, the position was that in the case of a transfer of a going concern, VAT incurred by the vendor on costs such as legal fees and surveyors fees was treated as a general overhead and recoverable in accordance with the vendors partial exemption method. If the acquiring business made a mixture of taxable and exempt supplies, the recovery of VAT incurred on the transfer of a going concern would be restricted. For the purchaser, recovery of input tax depended on the supplies made by the business.

The current position of Customs, as set out in Business Brief 8/2001 dated 2 July 2001, is that from 1 April 2001, VAT is recoverable by the vendor to the extent that it is incurred on services that have a direct and immediate link with the part of the business being transferred. This means that if a company which makes exempt supplies sells a business that makes fully taxable supplies, the VAT incurred on the transfer will be fully recoverable. The purchaser's position remains as before.

Nigel Popplewell FTII is a partner at Burges Salmon; he can be contacted on 0117 902 2782.

Categories: