Follow up

Stirling Investments case

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Tower Resources case

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HMRC guidance on indicators of non-supply

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Management charges between connected companies

Is there a supply?

The starting point is that you and your clients must always be clear about the basic definition of VAT, namely that it is a tax on the supply of goods or services made in the UK by a taxable person. In other words, if there are no goods or services being provided from a supplier to a customer, then VAT cannot be charged.

A taxable person is a business or person that is either registered for VAT or should be registered.

Pro advice. If your clients pay for a “service” and are charged VAT by a supplier but there is no actual service being provided, they cannot claim input tax. So, e.g. just issuing a sales invoice from one company to a connected company and describing it as a “management service” is not acceptable; the recipient cannot claim input tax.

Companies under common ownership

Your client who owns two limited companies as the sole shareholder and director will need to consider some important issues before making management charges between them for services:

• Are they both registered for VAT? If so, can the company receiving the services fully claim input tax on its expenses, i.e. it is not partially exempt.
• If the company making a charge for, say, management services is not registered for VAT, will the fees for management charges mean it will exceed the £85,000 (£90,000 from 1 April 2024) registration threshold and must register for VAT?
• Most importantly, do the management charges relate to actual supplies, i.e. there is a logical basis to the charging arrangement according to costs incurred?

Pro advice. If two companies are under common control - or one company controls the other - a possible solution could be to form a VAT group. All supplies of goods or services made between group members are then ignored for VAT purposes because they are taking place within the circle of the group.

What is a management or service?

As explained above, your clients cannot just issue sales invoices between their connected and associated entities in order to move around profits, perhaps to make one company look more profitable than it actually is. The same rule applies to charges from a holding company to a wholly-owned subsidiary company. The commercial reality of a deal always takes priority with VAT, rather than phrases and sentences written on either a sales invoice or a legal contract. Are there genuine supplies taking place and do sales invoices reflect the fact that services have been performed?

Example. If a client issued a sales invoice to a customer saying they had provided zero-rated building services when they actually provided professional services as an architect - which are always standard-rated - their fee is still standard-rated. It is what work they have done that counts.

HMRC’s guidance (see Follow up ) instructs officers to check for “indicators that a supply is not being made” . For example, how can a holding company charge for management services if it does not employ any staff that can provide their time? How can management charges be made for the use of assets if no assets are owned by the holding company?

Pro advice. HMRC encourages its officers to challenge situations where the trader is unable to specify what supplies are covered by the charge.

Example. Consultant Ltd does not employ any staff, only three directors. The directors are common to another company, Advice Ltd; both companies are registered for VAT. Consultant Ltd has no business premises or tangible assets and there is no visible documentary evidence of supplies being made to Advice Ltd other than sales invoice(s) being issued for “management services”. The directors are unable to specify what supplies are covered by the charges.

HMRC would conclude, quite reasonably, that there are no taxable supplies of goods or services taking place. In other words, Consultant Ltd should not charge Advice Ltd for management services because there aren’t any! HMRC would disallow input tax claimed by Advice Ltd because it does not relate to taxable supplies of goods or services.

Pro advice. You might think that a management charge is acceptable here because a recharge could be made for time spent by the directors of Consultant Ltd on the business of Advice Ltd. However, this would be incorrect because their work for Advice Ltd is carried out in their role as directors of that company. This outcome is confirmed by HMRC’s guidance: “ Indicators that a supply is not being made include... the directors are common to both the holding company and the recipient of the services. ”

Holding companies

Clients which operate as a holding company cannot register for VAT if they only receive income from dividends, i.e. relevant to the shares they own in their trading subsidiaries. However, if they provide genuine supplies of management services to the subsidiaries, this would justify registering for VAT and claiming input tax on their expenses.

In reality, the same issues for holding company/trading subsidiary relationships must be considered as for the common ownership scenario of two trading companies. It is all about the supplies which are being made or otherwise.

Case law

The case of Tower Resources Plc (see Follow up ) considered whether a holding company was making management supplies to its overseas subsidiaries and could claim input tax on its UK expenses. The company (TRP) recharged its subsidiaries for management and logistical services, for acquiring licences to explore for and produce oil and gas in sub-Saharan Africa. The supplies made by TRP were outside the scope of VAT under the general business-to-business (B2B) rule for services because the place of supply for VAT purposes is where the customer is based, i.e. outside the UK. However, TRP had the right to claim input tax because its services would be taxable if they had been supplied to a UK entity.

HMRC challenged the company, saying that there was no economic activity, regardless of what the contracts said, pointing out that the invoices were charged to inter-company loan account balances. However, the Tribunal accepted that a genuine activity was in place: “ The provision of funding by a parent company to its subsidiaries through debt and/or equity is standard commercial practice. ” HMRC’s appeal was dismissed.

In the case of Stirling Investments (see Follow up ), a limited company owned jointly by Mr and Mrs Stirling was very profitable so a separate legal entity, a partnership between themselves, made a management charge to the company. Here are the facts:

1. The motive was solely to extract profits from the company, so the invoices issued by the partnership were based on company profits rather than the value of services provided. The partnership was registered for VAT, as was the company, so the invoices added 20% VAT to a charge of £525,000.
2. The company was partially exempt and suffered an input tax block on these invoices, so the tax advisors working for Mr and Mrs Stirling advised them to issue belated credit notes to cancel the management charge invoices (also crediting the VAT) and extract the profits from the company by declaring a dividend payment.
3. HMRC disputed the dividend approach but the Tribunal agreed with the taxpayers that the dividend method was reasonable. Dividends are outside the scope of VAT.

Pro advice. The Stirling case illustrates a potential own goal that your clients should avoid. If they make a charge for management services to a connected company that is partially exempt, there will be a leakage of tax because of the input tax block that applies with partial exemption.