Private Equity/Venture Capital set up – VAT considerations

When setting up a Private Equity or Venture Capital group with a UK Manager/Advisor, firms need to closely consider the UK VAT implications from both an offshore and onshore perspective.

Offshore Fund

Firstly, where the Fund and its General Partner (GP) are outside of the UK, the management fee charged from the UK Manager is outside the scope of UK VAT. Due to this, there is no obligation for the UK Manager to register for VAT, which presumably seems like the best way to proceed. However, as the management fees would have been deemed a VAT-able supply had the Fund been in the UK, the Manager can recover input VAT under Regulation 103 of VAT Regulations 1995. If the UK Manager registers for VAT, they would be able to reclaim VAT on the costs the business incurs, whilst not needing to charge VAT on the management fee it charges out.

Onshore Fund

Onshore structures are more complex however, and the best course of action is usually to create a VAT group. A UK Manager charging management fees to a UK Fund would be deemed to be a VAT-able supply. Unfortunately, the Fund is not permitted to be VAT registered in its own right, which means that whilst the Manager is obligated to charge VAT on its management fee, the Fund wouldn’t be able to recover it, causing Output VAT leakage. To remove this VAT leakage, a VAT group is formed with the Manager and the GP. The Fund, whilst not named in the VAT group, is deemed to be included, by virtue of its relationship with the GP. HMRC view a VAT group as a single entity, and so the management fee, now internal to this single entity no longer carries a 20% VAT charge.

There is, however, an opposing cost to forming a VAT group. The underlying activity of this single entity is now the buying and selling of equities, which is an exempt trade in the UK. This means that input VAT is restricted, and the group can no longer reclaim VAT on all or in some instances any of its costs. To reclaim a portion of input VAT, a Partial Exemption Special Method (‘PESM’) application needs to be made to HMRC. The PESM considers a series of possible scenarios for the group, broadly taking into consideration;

• Whether taxable supplies are made outside of the VAT group, e.g. Manager charging Directors fees, Monitoring fees, Arrangement fees etc. directly to the portfolio companies.
• Whether any of the portfolio companies are overseas entities – HMRC operate on the assumption that overseas investments will likely be sold to overseas customers. The sale of investments to an overseas customer is not deemed an exempt supply, and underlying input VAT on costs is recoverable.

Overall, in the majority of cases, the output VAT saving on forming a VAT group far outweighs the input VAT suffered on being deemed a partially exempt business.

Would you like to know more?

At Blick Rothenberg we have specialists who can review your individual case and group structure, provide advice and assist with VAT group registration and PESM application. If you would like to discuss any of the above, please speak to your usual Blick Rothenberg contact or Suzanne Beckett using the form below.