HM Revenue & Customs is challenging the right to reclaim VAT incurred on corporate restructuring costs.

Tony Bartle, senior VAT services manager at PKF Accountants & business advisers in Birmingham, said the new offensive had affected a wide cross section of businesses, not just those whose activities are exempt from VAT, and threatened to add substantially to the cost of M&A deals.

He said: "HMRC has previously allowed recovery of VAT paid on deal costs provided the deal creates a business that will eventually make 'taxable supplies' for VAT purposes. Over the last few months - and without any public announcement of a change in policy - it has been consistently disallowing VAT recovery by the 'NewCo' where the new entity is established late in the transaction process.

"HMRC claims that if the NewCo does not exist when engagement letters with professional advisers are signed, then it cannot be the recipient of the services provided under those contracts. Therefore, NewCo would not be entitled to recover the VAT charged by lawyers, accountants and other professionals assisting with the deal."

A number of test cases are currently proceeding to Tax Tribunals. There has already been a tribunal decision in favour of the taxpayer in the My Travel case, which dealt with a tripartite contract for corporate restructuring advice provided to the business and its financiers.

Mr Bartle said: "While the My Travel decision bodes well for tripartite contracts, the main issues are yet to be decided by the tribunals. Legal commentators are concerned that key points might be decided in favour of HMRC and that recovery of VAT incurred on deal costs will become significantly more difficult as a result.

"If you are planning a corporate finance deal during the current period of uncertainty, an attack by HMRC on VAT recovery should be expected and financial models and budgets adjusted to take account of the potentially irrecoverable VAT.

"The consensus among observers is that VAT recovery is best defended by creating the NewCo as early as possible in the process. The existence of NewCo demonstrates a firm intention to make taxable supplies and establishes a clear link between costs incurred and the activities that are eventually to be undertaken by the business. Engagement letters with advisers should clearly state that the services are being supplied to NewCo - if possible, naming the new entity on the paperwork.

"The early establishment of a NewCo is known to cause practical difficulties in areas other than VAT and the practice in the corporate finance world has previously been to wait until the deal is almost finalised before its creation. The threat of lost VAT recovery is, however, likely to be a strong incentive to reconsider well-established processes."