Navigating VAT on deal costs can feel uncertain and high-risk. The rules are complex, often shifting with case law and HMRC interpretation, and the stakes are high; missteps can mean unrecoverable VAT, increased costs, or unwanted scrutiny from HMRC. For businesses undertaking acquisitions, restructurings or disposals, finance teams and decision-makers often find themselves balancing commercial imperatives with the fear that their VAT position may be challenged. The result can be hesitation, lost value, and unnecessary pressure at what is already a critical moment in the business lifecycle.
Against this backdrop of uncertainty, the forthcoming Supreme Court decision in Hotel La Tour is especially significant. The case looks at whether VAT can be recovered on costs linked to an exempt sale of shares, where those funds are intended to support other taxable business activities. Given the topicality of transaction costs in general, our VAT team has taken a closer look at the rules around VAT recovery on share acquisitions, and what they mean for businesses navigating deals.
Recovering VAT on deal-related costs is a nuanced area of tax law that requires careful consideration of the nature of the acquisition and its connection to the acquiring entity’s economic activities. HMRC’s guidance emphasises that VAT recovery is only permitted where there is a direct and immediate link between the costs incurred and the taxable supplies made by the business.
General Principles of VAT Recoverability
The cornerstone of VAT recovery is the economic activity test. Input VAT can only be recovered if the costs incurred relate to taxable supplies made in the course of business. Where acquisitions are made purely for investment purposes, such as holding shares to earn dividends or capital gains,VAT recovery is not permitted, as these are not considered economic activities under VAT law.
Scenarios Supporting VAT Recovery
1. Management Services to the Target Company
VAT can be recovered if the acquiring entity (often a holding company or “HoldCo”) intends to provide genuine management services to the target company. To support this businesses should consider the following points:
- Management Services Agreement: A formal agreement should be established, detailing the services to be provided and the consideration to be received.
- Direct supplier engagement: Costs must be incurred by the HoldCo, with invoices addressed to it (not the target company) to demonstrate a direct link to the taxable supplies.
- VAT registration: The HoldCo must be VAT registered before incurring costs to avoid VAT leakage.
2. Extension of Existing Economic Activities
VAT recovery is also permitted where the acquisition is a strategic extension of the acquiring company’s existing taxable activities. Examples include:
- Acquiring a competitor or complementary business
- Integrating a key supplier or customer
- Achieving procurement savings or operational efficiencies
- Expanding into new but related markets (e.g., moving from pubs to bars)
In these cases, the acquisition supports and enhances the existing business model, and a management agreement is not strictly necessary.
Applying Acquisition Drivers to VAT Recovery
The rationale behind the acquisition can strengthen the case for VAT recovery:
- Venue expansion: Adding new locations supports business growth.
- Diversification: Entering complementary markets (e.g., bars vs. pubs) is a valid economic activity.
- Efficiency gains: Streamlining operations and procurement supports VAT recovery.
- Integration: Merging functions for synergy demonstrates a business purpose.
Key Risks to Be Aware Of
While there are strong arguments for VAT recovery, businesses must be cautious of the following risks:
- Insufficient documentation: Lack of formal agreements or misaddressed invoices can undermine recovery claims.
- Timing of VAT registration: Delayed registration may result in unrecoverable VAT.
- HMRC scrutiny: HMRC may challenge the genuineness of management services or the strategic nature of the acquisition.
- Investment vs economic activity: Acquisitions made solely for investment purposes will not qualify.
Recommendations for Businesses
To strengthen the position for VAT recovery on deal costs, businesses should:
- Establish clear intentions: Document the business rationale behind the acquisition.
- Formalise agreements: Put in place management service contracts where applicable.
- Ensure Proper invoicing: Costs must be invoiced to the acquiring entity.
- Register for VAT early: Avoid VAT leakage by registering before incurring costs.
- Maintain robust records: Keep detailed documentation to support the link between costs and taxable activities.
Conclusion
VAT recovery on deal costs is achievable when acquisitions are tied to genuine economic activities. Whether through management services or strategic business expansion, the key is to demonstrate a clear and documented link between the costs incurred and the taxable supplies made. While HMRC may challenge certain aspects, a well-prepared and evidence-backed approach can significantly strengthen the case for recovery.
Find the silver linings to VAT with experts who are analytical yet personable
At HaysMac, our specialist VAT team works with businesses to bring clarity and confidence to complex VAT questions. We combine deep technical expertise with a practical, commercial approach, helping you structure transactions in a way that supports recovery and withstands HMRC scrutiny. Whether you are planning an acquisition, integrating a new business, or restructuring for growth, we focus on protecting value, reducing risk and easing the administrative burden, so you can move forward with confidence, knowing your VAT position is in safe hands.
