The nuances of input VAT recovery

Central to the operation of the VAT system is the principle that a fully taxable business should not have to face the burden of irrecoverable VAT. The right of a business to recover the VAT that it incurs is a fundamental principle of the VAT system.

Notwithstanding the importance of the right to deduct input VAT, the exact circumstances when this right can be exercised have been the subject of much debate over the years. Guidance has been formulated by the Courts to help clarify when VAT recovery is possible. Specifically, the Courts have determined that VAT recovery is possible when there is a “direct and immediate link” between the VAT incurred and the business’ activities and this has been considered further both in the UK and Europe.

Within the UK, the recent focus has been on the VAT recovery position of holding companies and, specifically, the features that HMRC require to be demonstrated in order to allow holding companies to recover VAT. Most recently, HMRC have issued updates to their internal manual on input VAT recovery, to clarify further their view on VAT recovery for holding companies. Although elements of the guidance have proved difficult to address in practice, the updates to the manual do reflect closely the principles held in recent UK and EU case law, including for example the decisions of the Court of Justice of the European Union (“CJEU”) in Case C-108/14 / Case C-109/14 Larentia and Marenave Schiffahrt and Case C-28/16 MVM Magyar Villamos Muvek Zrt.

An important trend that seems to have become apparent at a European level is the variable messaging from the CJEU as to the extent to which the failure or otherwise to meet formal requirements can impact the extent to which fundamental VAT principles and reliefs are applicable. For example, in Case c-21/16 Euro Tyre BV, the CJEU came to the view that a taxpayer’s failure to meet the formal requirements laid down by the Member State did not preclude VAT relief being granted, as long as the objective characteristics for the granting of relief set out in the Principal VAT Directive were met. This can be contrasted with the decision of the CJEU in the Hungarian reference of Case C-564/15 Tibor Farkas where, at its simplest, the taxpayer’s failure to comply with the formalities the Hungarian authorities had put in place prevented an action in the first instance against the tax authorities.

What is clear from the above is that although the right to deduct is a fundamental principle, its exact application is subject to various different and developing factors. It is therefore important for businesses to monitor these developments and proactively consider their position.

Prem Mehta
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Prinal Nathwani
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