In its decision dated 7 March 2013, the European Court of Justice ("ECJ") held that advisory services concerning investment activities of an investment fund, provided by a third party advisor to the management company of the fund, fall within the VAT exemption for the management of investment funds. This applies irrespective of whether the advisor is subject to regulation or oversight by a supervisory authority.
The decision specifies and gradually extends the principles regarding the scope of the VAT exemption for outsourced management of investment funds, as set forth in the ECJ decision "Abbey National" (see I. below).
The ECJ decision will have a significant practical impact on private equity funds and other alternative funds. It might give rise to new structural alternatives, in particular for time periods following the transposition of the AIFMD into national law (see II. below).
I. Details of the Decision
1. Question Referred for Preliminary Ruling
The ECJ made the judgment dated 7 March 2013 in answer to a question for a preliminary ruling referred to it by the German Federal Fiscal Court ("BFH"; resolution dated 5 May 2011). The BFH asked whether and under what conditions advisory services provided by a third party to an investment management company (IMC) concerning investment in transferable securities fall within the concept of "management of special investment funds" for purposes of the VAT exemption pursuant to art. 13B(d)(6) of the Directive 77/388/EWG or art. 135(1)(g) of the amended Directive 2006/112/EG (collectively: "VAT Directive").
In the case at hand, the BFH had doubts as to whether services rendered by a third party service provider fulfilled the criteria developed by the ECJ in the Abbey National decision (C-169/04). According to this decision, the VAT exemption covers services performed by a third-party manager in respect of the administrative management of the funds, if, viewed broadly, they form a distinct whole, and are specific to, and essential for, the management of those funds.
A German IMC entered into a service agreement with a consultancy firm. The consultancy firm undertook to provide advice relating to the management of a German investment fund (Sondervermögen) by the IMC and to make recommendations for the purchase and sale of assets, taking into considerations the investment policies and investment restrictions of the investment fund. After checking that the recommendations received from the consultancy firm did not infringe any relevant investment restrictions, the IMC implemented them. The final decision and final responsibility continued to lie with the IMC.
3. Line of Argumentation
The ECJ disagreed with the arguments brought forward by the BFH and clarified, inter alia, the following:
Management services provided by a third party manager" fall, in principle, under the concept of the management of investment funds pursuant to the VAT Directive.
Services consisting in giving recommendations to an IMC to purchase and sell assets are intrinsically connected to the activity characteristic of the IMC. The fact that the final decision and final responsibility for implementing the investment recommendations continues to lie with the IMC (i.e. that advisory and information services provided by a third party do not alter the fund's legal and financial position) does not preclude the application of the VAT exemption to such services.
Finally, the VAT exemption for outsourced advisory services is to be applied irrespective of whether the advisor is registered or authorized for the purpose of asset management.
II. Impact of the Decision
1. German Investment Funds
Under German national law, only the management of investment funds (Investmentvermögen) within the meaning of the German Investment Act (Investmentgesetz), i.e. contractual-type investment funds and investment stock corporations, is exempt from VAT; § 4 no. 8 lit. h German VAT Act (UStG). As a consequence, the management of German private equity funds is subject to VAT.
But even with respect to investment funds within the meaning of the German Investment Act, the German tax authorities take a restrictive approach and grant the VAT exemption with respect to outsourced investment services only where the entire fund administration is outsourced to the same service provider. In our judgment this position is inconsistent with the recent ECJ decision.
2. Non-German Private Equity Funds
Unlike Germany, most EU member states apply the VAT exemption for the management of investment funds also with respect to alternative investment funds ("AIF"), such as private equity funds. Thus, services relating to the management of, for instance, private equity funds organized under Luxembourg law (SICARs or SICAF-SIF) are exempt from (Luxembourg) VAT.
The recent ECJ decision confirms that advisory services rendered by fund advisors located in Germany to, for instance, a Luxembourg private equity fund (or its management) are VAT exempt, subject to certain requirements.
3. New Regulatory Framework (AIFMD)
The Directive 2011/61/EU on Alternative Investment Fund Managers ("AIFMD") and the German Capital Investment Act (Kapitalanlagegesetzbuch; "KAGB"; entry into effect as of 22 July 2013) provide that alternative investment fund managers ("AIFM") must perform at least portfolio management and risk management functions. While it is generally possible to delegate one of these two functions to a third-party service provider, such service provider must itself be authorized or registered for the purpose of asset management and subject to supervision or such delegation is subject to prior approval by the competent regulatory authority of the home Member State of the AIFM.
Based on the ECJ decision dated 7 March 2013 and subject to a thorough case-by-case analysis, it should be possible for an AIFM to obtain from an advisor advisory services, which do not trigger the application of the AIFMD with respect to the advisor, but are nevertheless VAT exempt.
The recent ECJ decision adds to the stability of the law and might provide for new structural alternatives. Therefore, it is to be welcomed.
However, the German national legal framework with respect to the management of German private equity funds remains problematic. The fact that the concept of the VAT exempt management of investment funds is limited to funds as defined under the German Investment Act (as opposed to AIFs) violates, in our judgment, EU law. This inappropriate discrimination of AIFs against certain eligible investment funds will presumable not be corrected in the context of the German Act on the Adaption of Investment Fund Taxation in Connection with the AIFM Directive (cf. our client information dated 12 December 2012 and 31 January 2013).
The situation could be remedied by change to EU law: Changes to the VAT treatment of insurance and financial services have been discussed on EU level for quite some time already. Further developments of these discussions are, however, difficult to predict at the moment.
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