Italy’s Supreme Court ruled on 9 August 2024 that a special purpose vehicle (SPV) involved in a merger leveraged buy-out (MLBO) transaction may deduct the input VAT related to transaction costs (Case No. 22608/2024). In reaching this decision, the court rejected arguments of the Italian tax authorities that the SPV was a static holding company that does not carry out any business activities so no VAT deduction should be granted. The Court explained that an SPV is not comparable to a static holding company, which is characterised by the mere holding of shares in other companies without directly or indirectly engaging in management, so a static holding does not qualify as VAT-taxable persons, whereas an SPV does qualify as a taxable person.
An MLBO transaction typically involves a vehicle established for purposes of the transaction that acquires the shares in a target company, with the acquisition financed primarily with borrowed funds. This is followed by a merger between the vehicle and the target, with the acquired company assuming the transaction debt. In a reverse merger, the target is the surviving company.
In the case before the Supreme Court, the MLBO transaction initially involved two companies: Beta and Gamma. Beta owned another company, Alpha. Beta and Gamma established Epsilon (the SPV) for the specific purpose of purchasing a significant proportion of Alfa's shares via bank financing to allow new shareholders to obtain control of Alpha. Following the purchase, Alpha carried out a reverse merger with Epsilon, which disappeared.
As noted by the Supreme Court, the steps in an MLBO transaction are as follows:
This leads to the question: is it possible to treat an SPV in an MLBO transaction in the same way as a static holding company whose entire existence is the mere holding of shares in other companies since it does not carry out any business activity and therefore is not a VAT-taxable person in Italy?
The Supreme Court’s view is that the fundamental difference between a static holding company and an SPV in an MLBO transaction is that the SPV is engaging in a preparatory activity with respect to the economic business to be conducted by the target.
Notwithstanding the fact that Epsilon does not engage in any sales transactions, a preparatory activity always constitutes the exercise of an economic activity so that, for example, the purchase of the goods and services necessary to allow an undertaking to actually commence its economic activity must also be considered instrumental and intrinsic to the performance of the future economic activity. In the case before the court, the input VAT on acquisition expenses (i.e., due diligence and legal advisory) must be considered deductible by the SPV and, following the reverse merger, by Alpha on the assumption of Epsilon’s legal relations.
It is worth noting that the Supreme Court specifically referred to the 2018 Ryanair decision of the Court of Justice of the European Union (C-249/17) where the CJEU states with respect to mixed holdings, that “any person with the intention…of independently starting an economic activity, and who incurs the initial investment expenditure for those purposes must be regarded as a taxable person.”
The Supreme Court decision is relevant for entities dealing with M&A transactions in Italy, whereas the clarification concerning an SPV’s right to deduct input VAT would imply a financial benefit consisting of the recoverability of VAT, which was previously considered an expense.
Francesco Grandolfo
Marco Bonfiglio
BDO in Italy
Overview of an MLBO transaction
An MLBO transaction typically involves a vehicle established for purposes of the transaction that acquires the shares in a target company, with the acquisition financed primarily with borrowed funds. This is followed by a merger between the vehicle and the target, with the acquired company assuming the transaction debt. In a reverse merger, the target is the surviving company.In the case before the Supreme Court, the MLBO transaction initially involved two companies: Beta and Gamma. Beta owned another company, Alpha. Beta and Gamma established Epsilon (the SPV) for the specific purpose of purchasing a significant proportion of Alfa's shares via bank financing to allow new shareholders to obtain control of Alpha. Following the purchase, Alpha carried out a reverse merger with Epsilon, which disappeared.
As noted by the Supreme Court, the steps in an MLBO transaction are as follows:
- Establishment of the SPV;
- Financing by means of debt capital;
- SPV acquisition of the target company; and
- Subsequent merger of the SPV into the target company.
This leads to the question: is it possible to treat an SPV in an MLBO transaction in the same way as a static holding company whose entire existence is the mere holding of shares in other companies since it does not carry out any business activity and therefore is not a VAT-taxable person in Italy?
Decision of the Supreme Court
The Supreme Court’s view is that the fundamental difference between a static holding company and an SPV in an MLBO transaction is that the SPV is engaging in a preparatory activity with respect to the economic business to be conducted by the target.Notwithstanding the fact that Epsilon does not engage in any sales transactions, a preparatory activity always constitutes the exercise of an economic activity so that, for example, the purchase of the goods and services necessary to allow an undertaking to actually commence its economic activity must also be considered instrumental and intrinsic to the performance of the future economic activity. In the case before the court, the input VAT on acquisition expenses (i.e., due diligence and legal advisory) must be considered deductible by the SPV and, following the reverse merger, by Alpha on the assumption of Epsilon’s legal relations.
It is worth noting that the Supreme Court specifically referred to the 2018 Ryanair decision of the Court of Justice of the European Union (C-249/17) where the CJEU states with respect to mixed holdings, that “any person with the intention…of independently starting an economic activity, and who incurs the initial investment expenditure for those purposes must be regarded as a taxable person.”
BDO insight
The Supreme Court decision is relevant for entities dealing with M&A transactions in Italy, whereas the clarification concerning an SPV’s right to deduct input VAT would imply a financial benefit consisting of the recoverability of VAT, which was previously considered an expense.Francesco Grandolfo
Marco Bonfiglio
BDO in Italy