Case: Input tax allowed on legal services incurred pre-incorporation

UKFTT 0502 (TC)

Judge Guy Brannan, Member Maryvonne Hands

Decision released 2 August 2019

VAT - input tax – pre-incorporation legal expenses – Value Added Tax Regulations 1995 (SI 1995/2518), reg. 111 – expenses incurred in proceedings against an individual who subsequently incorporated and became a director of appellant company – whether for the purposes of the business - appeal allowed

Koolmove Ltd [2019] TC 07305


Mr McKee, a skilled software programmer, was the sole director and shareholder of Koolmove Limited (the appellant). He had developed software ("the McKee software") in his spare time and intended to set up a company to commercialise it. Before he could do so a third party brought an action against him seeking to prevent him from attempting to exploit commercially the McKee software. Mr McKee successfully defended these proceedings and the appellant incorporated on 8 July 2016, shortly after the judgement.

The appellant applied and was registered for VAT with effect from 1 August 2016.

In denying the appellant’s subsequent claim for input tax in relation to the legal costs incurred by Mr McKee, HMRC suggested the services were provided to Mr McKee in his personal capacity and there was no evidence of a "clear and stated intention to incorporate [the appellant] and utilise the McKee software in the course of its taxable supplies at the time the court action was raised".

It was not disputed that input VAT incurred on supplies to a business can be reclaimed if it is attributable to taxable supplies by that business (VATA 1994, s. 24-26 ) and in accordance with those provisions VAT can only be recovered by the person to whom the services are supplied.

Regulation 111 of the Value Added Tax Regulations 1995 (SI 1995/2518), however, provides for input VAT to be reclaimed in certain "exceptional" circumstances. Input tax can be claimed by a company in respect of supplies of services made prior to its date of incorporation provided

(1)the supplies were for its benefit;

(2)the supplies were made to a person who became a member or officer of the company;

(3)he or she was not, at the time, a taxable person;

(4)he or she has been reimbursed for the whole of the price paid (or the company has undertaken to do so); and

(5)the supply was made for the purpose of the business to be carried on by the company and for its benefit or in connection with its incorporation.

HMRC noted there was no evidence the McKee software was owned by the appellant, who had not yet made any supplies. Secondly, the contract for the legal services had been between the legal firm and Mr McKee, not the appellant.

The appellant contended Mr McKee always intended to set up a company to exploit or commercialise the McKee software. Undertakings given in the legal proceedings prevented Mr McKee establishing and transferring the McKee software to the appellant. Instead, the appellant had been incorporated as soon as reasonably practicable after the action was settled. Following the decision in Oaks Pavilion Ltd [2010] TC 00145, once a definite intention to incorporate had been formed expenditure could be incurred and services received for the benefit of the company. The litigation, if successful, would have stopped the appellant from carrying on business. There was therefore a direct and immediate link between the services supplied and the business to be carried on by the appellant.

The tribunal agreed the supply of legal services was for the benefit of the appellant. It found that Mr McKee always intended to exploit the McKee software through a limited company. Secondly, it was satisfied the appellant had undertaken to reimburse Mr McKee. The legal fees incurred by Mr McKee were shown as a director’s loan in the appellant’s accounts. Thirdly, Mr McKee was not registered for VAT. Fourthly, Mr McKee incurred the expenditure for the purpose of a business to be carried on by the appellant. If the litigation had not been defeated by Mr McKee it would have been impossible for the appellant to carry on the business of exploiting the software. There was no evidence the legal services had been used for any other purpose.

On examination of the relevant invoices it was noted all but one fell within the relevant six-month rule. The one exception indicated some of the services were supplied after the date of incorporation and possibly also after the effective date of registration of the appellant. Accordingly, these amounts were not eligible for credit as input tax under reg. 111 but it was left to the parties to apportion the qualifying input tax accordingly.

The appellant’s appeal was allowed.


This case once again demonstrates the potential importance of documenting an intention to trade as soon as possible after that intention crystallises, regardless of whether that intention can be realised immediately.

In order to find in favour of the appellant, the tribunal had to find and accept evidence of an intention to set up the appellant company to exploit the McKee software at the time of the litigation. It was able to do so despite the fact the appellant had not existed at the time of the litigation and the McKee software had still not been transferred to the appellant at the time of the hearing.

For commentary on pre-incorporation expenses, see the In-Depth at ¶19-138.

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