Article: VAT on Intercompany services, management charges and overhead costs.

One of the most common VAT queries is whether VAT should be added to intercompany services, management charges and overhead costs; typically the charges made by a parent company to subsidiaries at the financial year end.  These are the type of queries that people ask as a sort of throwaway line as though it’s certain to be a quick yes or no answer, but of course it’s rarely that simple!

To decide whether you have to add VAT to the recharge, you have to answer one question:

Do the recharges represent consideration for a taxable supply?

In other words, what does the subsidiary company get in return for their share of the cost?

In practice there are 2 typical scenarios:

• In the first scenario, the parent company purchases various overhead business services and consumable goods from third parties – typically office and motoring costs – and makes them available to the subsidiaries in return for a share of the cost. The costs are usually the overhead costs of running a business which are consumed by the companies concerned, not goods or services for resale to customers.

Sometimes a mark up is added to the share of the cost, but in either case the charge at least covers the cost to the parent company of making the services available to the subsidiary.

Sometimes there is an agreement setting out how the costs will be calculated – in larger groups the mechanism can be very complex and done regularly on a monthly or annual basis. But in SMEs it’s often done on an informal basis with nothing in writing.

For want of a better term, I’ll refer to this practice as the provision of miscellaneous business services. As I’ve explained below in most cases the charges made to the subsidiaries for such services represent consideration for a taxable supply and are therefore be liable to VAT, although there are some important exceptions.

• Alternatively, recharging the expenses is simply a mechanism for working out the cost of other services provided by the parent company to the subsidiary. A typical situation would be where there is a management services agreement whereby the parent company provides services which are defined in such an agreement – for example consultancy services or the provision of management advice or services of certain employees – and the cost is based on a proportion of the costs incurred by the parent company.

The liability of the recharges in these cases will depend on the nature of the services provided to the subsidiary under the agreement.

I’ve discussed each of these scenarios in more detail below and also mentioned some potential problem areas, including partial exemption and the provision of services to overseas companies.

VAT and management charges – always a headache!

Miscellaneous Business Services

Typically the parent company will hold supplier accounts for facilities. For example the telephone account is in the parent company’s name, but the subsidiary also requires access to the telephone service in return for a share of the cost. In the case of salaries, recharges typically occur when one group company employs all of the staff and provides the other companies with their services in return for a share of the salaries and other employment costs.

If you need more information about this subject, you can buy my book as a paperback VAT on inter-company services, management charges and other day to day transactions from Amazon or buy the pdf version VAT on inter-company services and management charges from our shop

These charges are consideration for taxable supplies so therefore liable to VAT

These and other business facilities listed below are each standard rated supplies and any recharges of costs are liable to VAT at 17.5%:

• The provision of motor vehicles based on the cost of petrol and other car costs
• Telephone/internet services based on a proportion of the BT bills
• Use of office facilities based on the cost of utilities and shared office space and insurance costs
• Office materials, paper etc.
• Staff (though a bit more about this in a minute)

If you make a single charge for a combination of any or all of these various business services, it would represent consideration for a single standard rated supply

• But the parent company doesn’t pay VAT on the office insurance – do I have to add VAT on to that element of the recharge?

Typical VAT-free examples would include insurance or MOT costs. Insurance purchased from an insurance company to cover the group’s office premises or the cost of an MOT from a garage wouldn’t normally bear VAT. But if you recharge the costs, they would in most cases form part of a standard rated supply of insured office accommodation or the use of a car and the total amount charged would be liable to VAT.

There are, of course, important exceptions to this rule which include exempt property rent, certain staff costs and disbursements which in certain circumstances are not liable to VAT. I’ve talked about these and a couple of other issues in more detail below.

• Recharge of Property Costs

One recharge that could be exempt would be rent for the use of premises.

The rules about the VAT liability of property costs are complex and exemption would normally only apply if the subsidiary had exclusive use of a defined space in the office, either under a formal lease or licence to occupy the premises concerned or an informal arrangement which has the same characteristics in practic. In this case the recharge could be rent which is prima facie exempt from VAT.

This gets you into all sorts of difficult issues including exemption for supplies of land and buildings and the option to tax, which is another subject entirely and you really do need to look at the subject in further detail and consider taking formal advice.

HMRC VAT Notices 742: Land and Property and 742A: Opting to Tax Land and Buildings deal with the VAT liability of supplies of land and property and the option to tax, if you want to read up on these subjects.
There is also more information about recharges between landlord and tenant in VAT Notice 742: Land and Property, section 11 http://tinyurl.com/yaynp2p. This discusses services charges on commercial buildings and how different charges would be categorised for VAT purposes.

• Staff costs

Another intercompany cost that might not be liable to VAT is the recharge of employment costs. Again it depends on the specific circumstances. A common situation is where there is a joint contract of employment, for example an employee is contracted to work for all companies within a corporate group and the costs are recharged between the companies at the year end in the proportion of time that the employee allocates to each company. In this case the recharge would not be consideration for a taxable supply but is simply recouping the appropriate element of the salary cost, so this element of the charge would not be liable to VAT. The recharge of costs relating to directors’ services may also be VAT-free in certain circumstances.

Have a look at VAT Notice 70/34: Staff http://tinyurl.com/ybo8mky for further information on this subject. The notice is quite short and it’s worth spending a few minutes reading up on the subject in case any of the circumstances apply in your particular case.

• Disbursements

Certain costs are not liable to VAT because they are disbursements. This is when you have paid something on behalf of a third party and are recovering the exact amount from that person. A good example would be a solicitor collecting stamp duty from a client. In a corporate group situation, it could apply if the parent company had paid an invoice issued to one of the subsidiary companies and was recouping the cost from the subsidiary company. This wouldn’t be consideration for a taxable supply, so the parent company wouldn’t charge VAT on the recharge, nor would it be entitled to recover VAT on the original cost.

• Mixed supplies

This applies if some of the charge is liable to VAT and some isn’t. Suppose if you are recharging staff costs under a paymaster arrangement and also charging for the provision of the telephone service, the charge would have to be apportioned like a “mixed supply” and the parent would only charge VAT on the positive rated element. You can find more information on how to do this in the VAT General Guide Notice 700 Section 8.1 http://tinyurl.com/yb8skro

Management Services Agreements

The other scenario involving recharging of costs typically occurs when businesses – particularly corporate groups – set up management services agreements as a mechanism for dividing up costs between associated businesses or group companies. Typically a parent company acts as a management company providing certain services to the subsidiaries under formal agreements.

In this case you’d have to look at what the management company is providing to the subsidiary to establish the liability. It might be defined in the agreement as advisory services or the provision of services from specific staff members or directors.

In most cases the provision of management services, consultancy or advisory services will standard rated. However there are certain circumstances when the provision of directors’ services is not liable to VAT. See VAT Notice 700/34: Staff mentioned above for information on this subject.

If you need more information about this subject, you can buy my book as a paperback VAT on inter-company services, management charges and other day to day transactions from Amazon or buy the pdf version VAT on inter-company services and management charges from our shop

Look in our shop or Amazon UK for my book on this subject

Look in our shop or Amazon UK for my book on this subject

The important point is that the liability of the payment depends on what is being supplied under the terms of the agreement, not how the value of the payment is calculated or the consituent elements of the recharge. In this case the subidiary is not paying for business facilities such as telephone usage or other overhead costs but a supply of services as defined in the agreement.

Could intercompany recharges be consideration for exempt supplies?

It’s also possible that the parent company could be making a supply of services that are exempt from VAT albeit the cost is calculated by sharing out standard rated costs. This is quite unusual but can occur if the business is in the financial services or other exempt business sector. A good example would be the cost of the services of an Independent Financial Advisor that would be calculated by reference to a share of the staff cost plus office overheads.

• Why does this matter?

Businesses are either “fully taxable” or “partly exempt” for VAT purposes. “Fully taxable” is when most or all of the supplies that they make to third parties are taxable either at the standard rate of 17.5%, 5% or the zero rate and the business is not required to restrict its input tax recovery because of making exempt suppIies. A business is “partly exempt” if it makes some exempt supplies and is required to restrict its input tax recovery as a result.

If your business is liable fully taxable then it’s unlikely that any services provided between group companies would be exempt from VAT. But in the exempt business categories, it is possible that exemption could apply to intra-group supplies. It is a complex area and you probably need to look into this in more detail if you think it could apply.

Other Problem Areas

• What if the recipient can’t recover the VAT?

If the recipient of the supply can’t recover the VAT because they are partly exempt or not even registered for VAT, there may be ways to minimise the VAT cost. For example associated companies can choose to register for VAT in a VAT group registration which minimises VAT costs because VAT is not charged on transactions between members of the same VAT group. In the case of charges that are for a mixture of costs, it’s always worth considering whether any of the costs – such as the staff costs or rent – could be recharged free of VAT and whether this would represent a real saving.

This is a difficult area – there are some complex anti-avoidance rules that apply to larger partly exempt companies and group registrations. Even the “standard” partial exemption rules are full of potential problem areas and you’d be well advised to take professional advice.

See VAT Notice 700/2: Group and Divisional Registration http://tinyurl.com/ybdq3gh and VAT Notice 706: Partial Exemption here for further information on this subject.

• Supplies to overseas companies

There is often still an assumption that management charges or the recharge of any business costs made to overseas companies are always VAT free simply because the recipient is based overseas. This isn’t true. The service can only supplied free from VAT if it falls within certain categories as defined in the legislation which are “supplied where received” and free from UK VAT when the recipient is an overseas business.

If you need more information about this subject, you can buy my book as a paperback VAT on inter-company services, management charges and other day to day transactions from Amazon or buy the pdf version VAT on inter-company services and management charges from our shop

The categories are quite wide but it’s important to remember that one service that is NOT included is the provision of office facilities. So the provision of office overheads or other business facilities in the UK is liable to VAT even when the recipient is an overseas business

If, however, it is one of those cases where the cost of the facilities is used as a mechanism to calculate the cost of other services, then the charge could be categorised as the supply of consultancy services or another service that is “supplied where received” and thus free from UK VAT. “Consultancy services” fall within this category, but “management services” don’t, so do consider the VAT liability when agreements are being drawn up and see whether the services could be defined as something that falls within the “supplied where received” category.

Even if the supply is liable to VAT, the subsidiary may be entitled to recover the VAT charged through the EC VAT recovery scheme. And if there isn’t an agreement in place, then it may be worth investing in the cost of setting up a formal agreement that establishes the nature of the service being provided to avoid problems when sorting out the VAT liability in the future.

But either way, do take advice when services to overseas companies are involved to avoid having a VAT mess in the future, or check out the guidance about international services in VAT Notice 741A: Place of Supply of Services here http://tinyurl.com/ye67t2s

• Charging VAT incorrectly

And finally, a word of caution about charging VAT incorrectly

The simplest approach might be to take the view that “if I’m charging something, I’ll add VAT to the charge” assuming that this is the safest way of dealing with VAT issues. And in the past, I wouldn’t have been too worried about this approach – a visiting VAT officer is much less likely to query whether you’ve charged VAT in error than ask you to explain why you haven’t charged VAT on certain income.

But the world has moved on and there are other factors to consider, such as penalties for repeated errors – such as trying to reclaim input tax in error – and VAT officers who are better trained to identify mistakes.
Suppose the charges aren’t liable to VAT but should be VAT free, for example a recharge of salary costs relating to shared employees. In principle this would mean that the VAT charged on the invoice wasn’t “VAT”, so the recipient company wouldn’t be entitled to claim the amount as input tax on its VAT return. However the supplier would still have to include the “VAT” as output tax on its VAT return because the law requires that any amount shown on an invoice is paid to HMRC as a debt due to the crown.

Of course the supplier could issue a credit note for the VAT and recover the VAT overcharged on his VAT return, but it just makes a bit of a mess to sort out. Also if it’s propery related stuff, then it could be even more difficult to unravel. And there’s also the possibility of penalties for the parties involved, so it is worth spending the time upfront to get it right.

Don’t forget to email me marie@vatexchange.co.uk if you have any particular queries about this subject.

 

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