VAT in Private Equity
Navigating VAT in the private equity sector can be complex, but our latest article sheds light on how to effectively manage VAT in various contexts. We cover three key areas:
From understanding VAT groups and partial exemption methods for UK funds to leveraging Luxembourg’s VAT benefits and ensuring VAT recovery on transaction costs, this piece is packed with valuable insights.
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VAT IN PRIVATE EQUITY??
VAT is often an afterthought or not considered at all when it comes to private equity but here's why you should be thinking about it.
VAT often takes a backseat to other taxes in the fast moving and dynamic world of private equity. However, overlooking VAT can result in significant financial cost, compliance risks and missed opportunities.?
In this article, we highlight some of the ways in which to effectively manage VAT in 3 common areas:
1. VAT Recovery by UK Private Equity Funds
VAT Grouping?
In the UK, grouping an investment manager and the general partner of a fund within a VAT group is accepted practice. This setup prevents VAT leakage on fund management fees which tend to be taxable by disregarding them for VAT purposes, rather than charging VAT to the general partner of the fund that might be irrecoverable. However, including the general partner in the VAT group brings the fund and its activities into the VAT fold, usually resulting in partial exemption from full VAT recovery due to the fund's investment activities but typically that is less of a VAT cost than not VAT grouping.
Partial Exemption VAT Recovery Methods?
UK based private equity fund managers typically operate a partial exemption special method (PESM) which fairly and reasonably reflects the use of the costs and has to be agreed by? HMRC. The PESM typically segregates activities into sectors, such as exempt fund investment activities and taxable portfolio management activities, although HMRC’s recent update to its partial exemption internal manual suggests that a private equity fund may potentially have a non-business rather than exempt investment activity, the implications of which could further restrict VAT recovery. Given the dynamic nature of private equity, it's crucial to periodically review and update the PESM if necessary to ensure it is fair and reasonable and to improve future VAT recovery. This is particularly pertinent following events like the launch of a new fund or changes in asset holding structures. For example, costs like abort fees and fund formation services should be allocated across both fund investment and portfolio management sectors, which reflects where the costs fall commercially and enable VAT recovery. Additionally, post-Brexit, UK funds dealing with non-UK parties can treat disposals of investments as taxable transactions, potentially enhancing the VAT recovery rate under the PESM.
2. VAT benefits for private equity funds in Luxembourg
VAT Exemptions
Luxembourg is a popular jurisdiction for establishing alternative investment funds (AIFs) and? offers VAT benefits due to its distinct VAT laws. Unlike the UK, Luxembourg considers AIFs as special investment funds (SIFs) for VAT purposes, which means fund management services in Luxembourg are exempt.
In a UK-Luxembourg structure, this means:
However for these benefits to apply, it's crucial to demonstrate that AIF has sufficient substance in Luxembourg, for example to show that investment decisions are made by senior executives in Luxembourg and not just rubber stamped.?
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Establishment Costs and Transaction Fees
Typically, these costs are incurred by the UK investment manager, who should invoice them to the Luxembourg fund. This allows VAT recovery on these costs, which are then included in the investment management fees charged to the fund. Practical considerations include ensuring accurate invoicing and documentation to reflect the commercial intent and avoid penalties from tax authorities.
3. VAT Recovery on Transaction Costs
Buy-Side Costs
VAT recovery on buy-side costs is typically by a holding company. VAT recovery by holding companies is a contentious and evolving area of VAT. It is commonly challenged by HMRC and other tax authorities, where for example it may not be clear whether the holding company is or intended to be the recipient of the services, carrying on an economic activity or a taxable person. Therefore for VAT recovery purposes it is important to consider the following:
- whether? engagement letters, invoices and deliverables for services to be used by the holding company correctly describe the services and to whom they will be provided to;
- whether the holding company has clearly documented its intention to carry on an economic activity and to register for VAT; and
- whether the holding company has sufficient people and technical resources to carry on the economic activity.
Sell-Side Costs
VAT recovery on sell-side transaction costs is more complex, especially when selling shares to a UK buyer, as this is typically a VAT-exempt supply. However, recent case law suggests that in certain situations, VAT incurred on the sale of shares can be recoverable if the sale funds taxable activities. For instance, the Hotel La Tour case, although recently overruled, highlighted potential avenues for VAT recovery by looking beyond the immediate transaction.
To mitigate VAT leakage in sell-side transactions:
In conclusion, while VAT may not be high on the priority for private equity, its proper management at the earliest stage is crucial for minimising financial cost and compliance risks.?
If you think you could be managing VAT better, whether at the private equity fund, transaction or portfolio level, then please contact any of the below or your usual PwC contact.??
PwC VAT Contacts :
Jo Bello - Partner?
Email [email protected]
Ali Hai - Director?
Email [email protected]
Sean Climo - Senior Manager
Email [email protected]