We are aware of several private equity (PE) fund managers receiving “nudge” letters from HMRC concerning VAT compliance. This follows a similar campaign commenced by HMRC in summer 2024 focusing on retail fund managers and other financial services businesses. For retail fund managers the nudge letters were followed by proposed changes in HMRC policy, which are currently the subject of vigorous debate between industry representatives and HMRC. 

The PE nudge letters we have seen focus on the following areas: 

1. fair and reasonable attribution of input tax to supplies with a right to deduct under the partial exemption method;
2. use of taxed inputs; 
3. right to deduct input tax on the disposal of shares on exit of the investment;
4. verification of genuine supplies of management services to investment companies;
5. application of reverse charges; and
6. determination of whether supplies are made in the UK for VAT purposes.

Many of these topics will be familiar to PE fund managers as in many cases determining the correct VAT treatment requires a degree of judgement, with small changes in the facts potentially leading to very different VAT outcomes. 

To managers that are VAT-grouped with UK funds under their management the inclusion of partial exemption in the list (points one, two and maybe three) will probably not come as a surprise. Many such managers will have agreed partial exemption methods that include time-spent calculations in accordance with HMRC guidance contained in Control Note V1-37. The control note has been withdrawn by HMRC and for some years now they have signalled their dissatisfaction with such time-spent calculations, although they have not necessarily challenged their use in individual cases provided that the result produced is reasonable in their view. However, from our recent interactions with HMRC we understand that they will now challenge such methods as a matter of course, without considering the PE manager’s particular facts or the result produced by the method.

The fourth point suggests a greater focus by HMRC on whether Bidcos that have recovered VAT on deal costs based on their intention to provide management services to the target group have actually provided those services and charged for them.  

We expect that HMRC's focus on the reverse charge (point five) is primarily concerned with the question of whether (or the extent to which) services received from outside the UK are VAT-exempt as services of intermediating in transactions in securities. 

The sixth point is focused on the questions of who has received a supply for VAT purposes and where that supply has been received. PE asset holding structures are unusual in that they often present several reasonable options as to which entity should engage with service providers and be invoiced for particular services, each of which might be based in a different jurisdiction and have a different VAT recovery profile. 

Revenue raising is clearly a priority for the Government at the moment and past experience suggests that nudge letters of the type discussed above can be the first step in a project to raise revenues in areas where HMRC want to encourage taxpayers to ensure their tax affairs are in order. The contents of the nudge letters suggest that HMRC have spent some time determining where they believe the pressure points lie for PE fund managers. If you have received a letter, it will be important to understand the options available and for others not yet on the receiving end, it would be prudent to protect against potential future HMRC action.  

If you would like to discuss any of the points raised in this note with one of our VAT specialists, please get in touch.