HMRC is challenging VAT recovery by holding companies operating in the mining and exploration sectors. This is on the basis that HMRC do not believe that they are carrying out ‘business’ or ‘an economic activity’ for VAT purposes. Organisations operating in these sectors are, due to the speculative nature of their activities, and the way in which they are normally structured and funded, finding themselves potentially looking at significant irrecoverable VAT costs.
It is usual for businesses in the mining and exploration sectors to structure themselves by incorporating a UK holding company (which is often listed on AIM) and creating trading subsidiaries which carry out their exploration and production activities overseas. Because of the way in which the sector operates, and the requirements of the subsidiaries for support and funding from the holding company, the UK holding companies would often incur VAT on costs that do not have a clear and direct relationship to income that is a ‘taxable supply’ or equivalent for VAT purposes. HMRC has been taking an increasingly strict interpretation as to what VAT incurred on expenditure is recoverable, and there have been a number of appeals taken to the Tax Tribunal involving a challenge to VAT recovery.
In the case of two of the most recent appeals heard at the First-tier Tax Tribunal (Norseman Gold plc
and African Consolidated Resources plc
) HMRC successfully argued that the companies were not carrying out economic activities, i.e. were in business, and thus could not recover the VAT incurred on expenditure. This was the decision even though the tribunal accepted that the holding companies in both cases raised genuine management charges for services and support provided. However, the arrangements did not have a sufficiently commercial basis for the subsidiaries to pay the holding company for these services, even allowing for the fact that the parties were related companies. Norseman Gold plc has appealed to the Upper Tribunal, and further developments on this matter are expected to take place in the near future.
Where are we now?
The issue of VAT recovery by holding companies is a long running one, and there has been substantial case law in this area. This is not only for the mining and exploration sectors, but also holding companies in general. The key challenge by HMRC is broadly the same: do costs on which the VAT has been incurred clearly relate to a taxable supply or intended taxable supply made in the course of business? By implementing robust structures and proper planning, much of the risk of incurring a challenge by HMRC can be mitigated.
Holding companies should ensure that they clearly record what services and support they are going to provide to their subsidiaries, and how those subsidiaries should pay for these. This should not be on the basis of “when the subsidiaries can afford to pay” or the payment being based on a nominal amount, or the subsidiaries ability to pay. The test should be a commercial one, i.e. would a third party provider be prepared to provide the services for these agreed payment terms?
The prudent approach would be to ensure that the anticipated arrangements between the holding company and its subsidiaries are set out upfront in written agreements and these reflect the relationship between the parties. The agreements should also state what support services the holding company will provide, and how it will be remunerated for these.
For more information, please contact Deborah Jennings