Fair Recovery of VAT on Costs Relating to Shares

From 3 December 2004, new tax avoidance legislation was introduced. It relates to exempt incidental financial supplies such as most share issues (those that relate to raising capital) made to individuals or companies based in the UK and other EU member states. Barry Hincks from Qdos Consulting explains the implications.

Prior to 3 December 2004, input tax recovery on such a share issue would be determined by the partial exemption rules. Thus if the VAT incurred on the costs of making a share issue to individuals or companies in the UK or EU member states breached partial exemption de minimis limits, and in many cases they would, that VAT would be irrecoverable.

In order to avoid this, Customs take the view that some businesses arranged to have the cost of the share issue amalgamated with other normal costs, such as an accountant amalgamating the cost of share issue services provided with their audit fee, on one invoice.

By this device (under partial exemption rules) the amalgamated costs cannot be attributed directly to either an exempt or taxable supply and become "residual input tax". The rate of recovery of residual input tax is determined, if using the standard method, by calculating the percentage of taxable income to total income. (Partial exemption rules allow the income of the share issue to be excluded from this calculation, as its inclusion would produce a distorted result.) The resultant percentage is then applied to the residual input tax to produce the amount of VAT which relates to taxable supplies and is therefore recoverable. The remainder will relate to exempt supplies and is only recoverable subject to partial exemption de minimis limits.

This means that a fully taxable business that incurs VAT of £30,000 on the costs of a share issue, using amalgamated invoices will be entitled to full input tax recovery. Whereas if the share issue costs were invoiced separately, and therefore directly attributable to an exempt supply, the £30,000 would be irrecoverable as partial exemption de minimis limits would be breached.

To counter this perceived abuse, the new legislation directs that VAT on the costs of an exempt incidental financial transaction should be apportioned according to use. What this means in practice is that if an amalgamated invoice is received a value will have to be attributed to each of the supplies according to use, even to the extent of asking service providers to issue an invoice with separate values per service provided.

The treatment of the costs of a share issue to a business outside the EU remains unchanged.