Praesto - input tax recoverable on fees incurred in defending proceedings against its director
In Praesto Consulting UK Ltd v HMRC [2019] EWCA Civ 353, the Court of Appeal has held that a company was entitled to recover input tax on legal fees it incurred in defending civil proceedings brought against its director.
Background
Mr Ranson was a former employee of Customer Systems plc (CSP), an information technology consultancy and the claimant in civil proceedings against Mr Ranson. In 2009 Mr Ranson resigned to set up Praesto Consulting UK Ltd (Praesto), which carried on a consultancy business in competition with CSP.
Praesto paid legal fees in relation to the civil proceedings brought against Mr Ranson by CSP. The issue was whether Praesto was entitled to credit for input tax on VAT charged by the law firm conducting the litigation on behalf of Mr Ranson.
HMRC denied Praesto's claim and it appealed.
The First-tier Tribunal (FTT) allowed Praesto's appeal. It found that both Mr Ranson and Praesto had been clients of the law firm and the input tax had been incurred in relation to legal services supplied to Praesto. The fact that Praesto was not a party to the litigation did not affect that conclusion. Praesto had made the profits from any breach of duty by Mr Ranson and Praesto’s profits would have to be accounted for, either by Mr Ranson or by Praesto itself, if CSP’s claim was successful. Praesto therefore had a direct interest in CSP’s claim being dismissed, so that the link between the supplies and Praesto’s taxable activities was sufficiently direct and immediate to entitle it to the input tax credit. The supplies had been made for the purpose of its business.
HMRC successfully appealed to the Upper Tribunal (UT). In the view of the UT the legal services were not used by Praesto for the purposes of its business.
Praesto appealed to the Court of Appeal.
Court of Appeal judgment
The appeal was allowed.
Although the FTT made no express finding of a contractual relationship between the law firm and Praesto, the findings of fact the FTT made clearly established a relationship. Mr Ranson and Praesto were jointly and severally liable for the law firm's fees and there was nothing significant in the fact that it addressed its invoices to only one of the parties so liable. In the view of the Court, there was no error of law in the FTT's conclusion that the invoices related to services supplied by the law firm to Praesto.
The Court considered whether Becker (C-104/12) applied to the circumstances of the case. The FTT and the UT had reached opposing conclusions on this point. In Becker, the Court of Justice of the European Union held that legal fees invoices to a company were not deductible because the lawyers in that case were defending two directors of the company who had been charged in their personal capacity with making illegal payments to secure a contract for the company. The Court agreed with the FTT, that Becker was distinguishable from the instant case and the UT was wrong to conclude otherwise.
The consequences of a finding of liability on the part of Mr Ranson would result in a real risk of proceedings being successfully brought against Praesto with disastrous consequences for its business activities. Praesto therefore had a direct interest in CSP's claim being dismissed and the benefit was not merely "incidental", as the UT had found.
The Court also considered whether the services supplied by the law firm had a direct and immediate link to Praesto's taxable activities. In its view, the FTT applied the right legal test. It had regard to all the circumstances surrounding the transactions at issue, looked for an objective link and found that objectively the reason Praesto obtained the legal services was to limit any liability arising from its taxable activities. In particular:
1) The services were supplied to both Mr Ranson and Praesto, under a joint retainer.
2) The supply reflected the economic reality. The proceedings were effectively being brought against Mr Ranson and Praesto, targeting the profits made by Praesto with the aim of putting it out of business.
3) There was a real risk of a successful claim being brought against Praesto by CSP if breach of fiduciary duty by Mr Ranson was first established.
4) Objectively, the reason Praesto retained the law firm's services was to avoid the real risk of it being liable to CSP which, if established, would have meant accounting for the profits of its taxable activities with the consequence that it would have been unable to continue to trade.
Commentary
The circumstances in which a company will be able to claim VAT in relation to legal fees incurred in defending a director against a legal claim will very much depend upon the individual circumstances of the case. The facts in Praesto were ultimately distinguishable from those in Becker. In order to successfully claim input tax it would appear that the consequences of a finding of liability against the director must be such that it would result in a real risk of proceedings being successfully brought against the company with adverse consequences for its business activities. The benefit to the company of a claim against a director being dismissed must not be merely "incidental".
A copy of the judgment can be viewed here.