There may be a time when a company decides it needs to raise capital. This could be for a variety of reasons, such as to finance a new business venture or to service existing debts. Whatever the reason, the directors will need to consider in detail how best to raise the desired funds. This will generally require them to take professional advice on the relevant tax, legal and other implications associated with different types of capital raising activities.
However, what often gets overlooked, or left until the last minute, is the VAT implications of these different methods of raising capital. This can potentially result in significant costs incurred by the business, which could otherwise have been avoided or mitigated by taking the appropriate advice. In this article, we briefly explore the VAT implications of different methods of raising capital.
Equity funding – Share issue
Where a company issues new shares, it's essentially selling a share in the ownership of the company. This can be achieved in several ways, such as through equity-based crowdfunding or private equity investment; the nature of the investor will most likely be dependent on the size and maturity of the business.
Where new shares are issued, this isn't considered to constitute a business activity, and the money received is treated as 'outside the scope' of VAT. In issuing the shares, the company isn't treated as making a supply. As such, no VAT is chargeable on the money received from the investors. The money received also has no effect on the company's entitlement to recover input VAT that it incurs on the costs of the business. It isn't included in calculating the business's partial exemption recovery percentage.
Where VAT is incurred on professional fees in connection with a share issue, this is treated as residual input VAT and a general overhead of the business. As such, the company will be entitled to recover this VAT in line with its normal partial exemption methodology.
Issue of other types of securities
The VAT treatment of share issues, explained above, was determined following the high-profile VAT case of Kretztechnik at the European Court of Justice in 2005. Following this case, HMRC's stated policy is that where a business issues another type of security, such as bonds, debentures or loan notes to raise capital for its business activities, these issues are also not to be treated as supplies and are treated for VAT in the same way as share issues.
Sale of existing shares
Another possible way of raising funds might be to sell existing shares held by the company. This could involve disposing of a subsidiary or selling shares held as investments.
Purchaser belongs in the UK
A sale of existing shares is considered a business activity and is treated as an exempt supply for VAT. As such, no VAT is chargeable on the money received. VAT incurred on professional fees relating to a sale of shares is not recoverable where it's directly attributable to an exempt supply.
This has been the accepted VAT position for many years. However, in the high-profile VAT case of Hotel La Tour, which is currently working its way through the UK court system, the taxpayer is seeking to argue that professional fees incurred in disposing of a subsidiary should be recoverable due to being attributable to the wider downstream taxable business activities of the company that were the reason for raising the funds. It's anticipated that this case will finally be concluded at the Supreme Court, so watch this space for future developments.
Purchaser belongs outside the UK
It is worth noting that a special VAT treatment applies regarding shares that are sold to persons belonging outside the UK. Such supplies fall within a category of mainly financial services, which are known as 'specified supplies'. Where a UK business makes such 'specified supplies', it's entitled to recover the attributable input VAT, such as the VAT incurred on associated professional fees, even though the sale of the shares would be exempt if made within the UK.
Debt Finance
Another way of raising funds is through debt finance, where a business borrows money from a third-party lender, such as a bank or other type of financial institution. Debt finance can take different forms and may be secured or unsecured. Typically, the business borrowing the funds will generally be required to pay interest on the principal amount borrowed.
In this scenario, the business that borrows the money isn't treated as making a supply and the loan will also not affect the business's entitlement to recover input VAT on its costs. This transaction is excluded from the calculation of the business's partial exemption recovery percentage.
Where VAT is incurred on professional fees in connection with debt finance, this is likely to be treated as residual input VAT and a general overhead of the business. As such, the company will be entitled to recover this VAT in line with its normal partial exemption methodology. However, VAT recovery needs to be carefully considered and there may be instances where the facts support a different position.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.