The Supreme Court delivered a landmark judgement, ruling that a company cannot reclaim tax on professional fees incurred during a share sale, even when the proceeds are used specifically to fund future taxable business activities.

Facts:

The appellant, Hotel La Tour (HLT), owned a luxury hotel in Birmingham through its subsidiary, Hotel La Tour Birmingham Ltd. (HLTB). HLT provided management services to HLTB, which established its relationship as a “taxable economic activity”. In 2015, HLT decided to develop a new hotel in Milton Keynes. To raise the necessary capital, HLT sold its shares in HLTB and took out a loan from a bank.

To facilitate this sale, HLT incurred over £76,000 in VAT on professional fees. HLT sought to deduct this “input VAT” from its “output VAT” (the tax it charged customers), arguing that the fees were linked to its future taxable hotel business in Milton Keynes. HMRC disallowed the deduction.

The First-tier Tribunal (FTT) ruled that HLT could reclaim the VAT based on the fact that the ‘direct and immediate link’ was not with the sale itself, but with HLT’s overall taxable hotel business. They reasoned that the sole purpose of the sale was to raise funds for the new Milton Keynes hotel. The FTT found that the professional fees were not “incorporated” into the price of the shares, which further suggested the costs were general overheads of the parent company. The Upper Tribunal (UT) broadly upheld the FTT’s analysis. The Court of Appeal (CoA), however, allowed HMRC’s appeal, holding that a direct and immediate link was with the exempt share sale and not with HLT’s overall taxable business, so the fees were not deductible. HLT then appealed to the Supreme Court.

Decision:

The Supreme Court unanimously dismissed the appeal, holding that the VAT incurred on professional fees for the share sale was not deductible. The most significant part of the Court’s reasoning was the rejection of the idea that the “purpose” of raising money could change the VAT status of the costs. The Court held that the “direct and immediate link” test must focus on the transaction that consumes the services as determined by the objective nature of the transaction (i.e., the share sale), and not the subjective intention of the business (i.e., using the money to build a new hotel)

The Court noted that in most businesses, money goes into a “common pot”. If the law allowed companies to claim VAT back based on where they intended to spend the proceeds, it would invite manipulation and create significant legal confusion regarding which project “owned” which funds.

The sale of shares in HLTB was an economic activity “within the scope” of VAT, although it was “exempt”. The Court ruled that an exempt transaction is a “barrier” to VAT recovery. Because the professional fees were used for this exempt sale, the “chain” of deduction stopped there.

The lower tribunals had argued that, because the professional fees were not “built into” the share price (shares are sold for market value and not a calculated cost), they must therefore constitute general business overheads. The Supreme Court rejected this, stating that the “cost component” phrase used in previous case law is not a literal test. Whether the price of the output is mathematically linked to the cost of the input is irrelevant to the “direct and immediate link”.

Implications:

By dismissing the appeal, the Supreme Court has closed a significant door that taxpayers hoped would allow for greater flexibility in reclaiming VAT on corporate transactions. Companies must now budget for professional fees, such as legal, accounting, and brokerage, as being VAT-inclusive.

The most critical takeaway is the definitive rejection of the “purpose-based” approach to VAT attribution. Taxpayers can no longer argue that VAT on professional fees is deductible simply because the ultimate goal of a transaction is to fund a taxable activity, as tax is determined by what the service is directly used for, and not what the resulting cash might be employed for later.