In the recent case of Melford Capital General Partner Ltd, a UK private equity fund was found by the First-tier Tribunal (FTT) to be entitled to full VAT recovery on its establishment and operational costs.
The FTT reached its decision based on the specific facts of the case and in particular, the way in which the fund and its assets were structured. Managers of UK based private equity funds should nonetheless consider whether they might be entitled to make a claim for VAT incurred in the past (to the extent to which it has not been recovered) or whether there might be an opportunity to amend the way in which arrangements are structured going forward so as to improve their VAT recovery position.
The key facts in the Melford case were as follows:
- a UK manager was VAT grouped with the UK general partner (GP) of a fund LP (VAT Group 1);
- below the Fund LP was an Isle of Man (IoM) holding company (Holdco) and below that a number of IoM property holding special purpose vehicles (SPVs) (the IoM is effectively part of the UK for VAT purposes). The holding company and the SPVs were VAT grouped (VAT Group 2);
- fund LP funded IoM Holdco partly by subscribing for shares and partly by the granting of interest free loans. The Holdco in turn funded the SPVs; and
- the UK manager supplied investment and administrative advisory services to the GP (acting on behalf of the fund) as well as to Holdco and each of the SPVs. The UK manager charged each of the recipients for these services.
HMRC argued that:
(a) VAT incurred by the GP on establishment costs was irrecoverable as it related wholly to investment activities, which HMRC considered were not economic activities for VAT purposes; and
(b) VAT on operational costs had to be apportioned between the supposed non-economic investment activities and provision of the investment and administrative advisory services and was therefore partially recoverable.
The FTT found that VAT incurred on both types of costs was recoverable in full. VAT grouping meant that the structure essentially involved two entities from a VAT perspective, VAT Group 1 and VAT Group 2. VAT Group 1 did not undertake any separate “non-economic” investment activities; all of its activities were economic activities because they involved the provision of services (investment and administrative advisory) in return for payment. Essentially the FTT saw VAT Group 1 as being analogous to a holding company and, based on the body of case law dealing with holding companies, found that it was entitled to full VAT recovery of its costs on the basis that it actively managed each of its “subsidiaries” (being the members of VAT Group 2) in return for payment.
It is worth noting that the fact that IoM Holdco and its subsidiaries were VAT grouped together was not material; the important point is that they were outside VAT Group 1 and therefore the services supplied by the UK Manager to the members of VAT Group 2 gave VAT Group 1 the right to input VAT recovery.
The analysis applied by the FTT stands in contrast to HMRC’s long-held view of how the activities of private equity funds should be viewed from the perspective of VAT. Whether HMRC will appeal the decision remains to be seen but the FTT’s decision is founded on what are now well-established principles of VAT.
It is accepted by HMRC that the Operating Costs are recoverable as input tax to the extent that they relate to the economic activity undertaken.