The exclusive purpose of a Pure Holding company is the acquisition and holding of shares as an investment activity with the intention of receiving dividend income. For VAT purposes, this does not qualify as an economic activity and consequently the company does not have the status of a taxable person.
Pure Holding Companies, by definition are not performing economic activities and have neither the obligation nor the right to register for VAT purposes and consequently they cannot claim back input VAT.
However, the minute a holding company starts to be involved in additional taxable economic activities such as:
- direct or indirect involvement in the management of its subsidiaries for a consideration. The economic activity involves not only supplying services for consideration but also for the purposes of obtaining income on a regular basis. We note that management services are very widely defined and usually are of administrative nature, accounting or information technology services or even property management of its subsidiary such as leasing;
- provision of interest-bearing financing to its subsidiaries (unless the financing is sourced from dividends distributed by the subsidiaries to which finance is granted);
- trading in shares i.e. purchasing and selling shares on a frequent basis with the intention to profit from the fluctuations of the share price;
then the Pure Holding Company becomes a Mixed Holding Company that may create an obligation or have a right to register for VAT purposes.
Much is written on VAT and Mixed Holding Companies partly because of the plethora of cases, and partly because, the area brings out some important principles, relevant not only to holding companies but to input VAT recoverability in general.
Criteria for recovery of Input VAT
There are three questions which must be answered affirmatively for a holding company to recover the VAT on its costs:
- Is the holding company a taxable person carrying on an economic activity?
- Is the holding company the recipient of a supply service?
- Is there a ‘direct and immediate’ link between the costs incurred and a taxable economic activity?
When dealing in shares, the consequences in terms of input VAT deduction are not always consistent and instead they depend on the taxable status of the person holding them.
The following summarizes the grounds on which a holding company may entitled to claim back input VAT.
Holding of shares – Deductible as overhead cost if the holding company meets the ‘direct and indirect involvement test’ and supplies taxable transactions. Partial attribution applies if the holding company manages some of its subsidiaries.
Receipt of dividends – Exempt income and they should be excluded from the denominator of the fraction used to calculate the deductible proportion.
Interest on loans – Exempt income and it should be excluded from the denominator of the fraction used to calculate the deductible proportion. Exemption to this rule is interest income deriving from loans from non-EU countries.
New issue of shares – They are deductible if there is a ‘direct and immediate link’ to the overall business activity, thus treated as overhead costs. When the company performs taxable and non-taxable activities, the apportionment calculation is required.
Disposal of shares – No entitlement since costs are related to an exempt transaction. Costs can be recovered if there is a ‘direct and immediate link’ or when the sale is regarded as a transfer of going concerned.
Input VAT of Mixed Holding Companies, that cannot be attributed to a single activity, is required to be apportioned between business and non-business activities and then between business activities that have the right to recover the input VAT vs. the business activities that do not have such right.
It is evident that the treatment of VAT of Holding Companies is a grey and complex area under certain circumstances. Holding companies should therefore plan carefully as in most cases the recoverability of input VAT depends on how the costs incurred are classified.
Given the recent VAT amendments (click here to read our relevant previous article) and the increase in VAT related penalties it is advisable that all companies perform an annual VAT audit on their activities and transactions to ensure compliance but also reducing the risk of a big VAT liability in the future.