UK: Financial Services And Markets Group Bulletin - A Review Of Financial Regulations And Tax Issues For FSA-Regulated Businesses. Feeling the Pressure.

Last Updated: 21 September 2010
Article by Natasha Lee


Welcome to our September 2010 edition of the Financial Services & Markets Group newsletter.

In light of the FSA's recent crackdown on how firms manage and control client money, we explore how firms may wish to review their current arrangements, particularly in light of the FSA's consultation paper on client money, CP 10/09 Enhancing the Client Assets Sourcebook.

The big news of recent months has been the Coalition Government's decision to abolish the FSA and replace it with a new regulatory structure in 2012. This newsletter provides an update on the proposed structure and how it may affect firms going forward. Firms may also be encouraged to provide feedback on how they view the new proposed structure via the Government's consultation process which ends on 18 October 2010.

 Martin Sharratt, Smith & Williamson's head of VAT, who specialises in financial services, provides some helpful pointers on the reverse charge, which is essentially VAT on 'imported' services, which can be a significant cost to financial services firms.

Finally, there is no place like home. Colin Aylott provides insight into UK tax changes that finally make the UK a more attractive place for establishing a fund.

If there are topics of interest which you would like us to cover in future newsletters please do let us know by emailing Please also remember to check out our monthly Financial Services bulletin e-shot, and if you are not a current subscriber you can register via our website, I hope everyone has a successful start to the new term following their summer holidays. 


With large fines, firm visits and the introduction of new proposals for CASS firms, now is a good time to review your current client money arrangements.

Under FSA Principle 10 (Clients' assets) "a firm must arrange adequate protection for clients' assets when the firm is responsible for them". The FSA has made it very clear that this protection is a regulatory priority during 2010.

Following on from its 'Dear CEO' letters and the publication of its Client Money & Asset Report which were sent to firms with permission to hold client money and assets during January 2010, the FSA has continued with its firm visits, some of which have resulted in headline making fines. The most high-profile case related to a firm being fined a record breaking £33.3m for failing to segregate client money appropriately in accordance with the Client assets sourcebook (CASS) rules over a seven year period.

There have also been other significant fines levied against other types of organisations in addition to firms being subject to skilled persons reports in the form of regulatory assurance reports under s166 of the Financial Services and Markets Act. These fines and s166 reports along with the establishment of a new client asset unit in addition to the consultation paper (CP 10/09 Enhancing the Client Assets Sourcebook) are a clear indication that the FSA will continue with its programme of intense supervision, and that it will take action where it believes client assets are not protected sufficiently.

The Proposals

The consultation paper contains a number of proposals. Some that will impact on CASS firms include the following. Establishing a CASS oversight controlled function The draft rules will require one person at certain firms to have ultimate oversight responsibility for client money and assets. This person will perform a proposed controlled function (CF) – the client assets oversight function.

Reintroducing a Client Money and Assets Return

The FSA has proposed a new return framework by reintroducing a client money and asset return (CMAR). The CMAR will need to be reviewed and authorised by the newly established CASS oversight CF on a monthly basis for medium and large firms and bi-annually for small firms (based upon a bespoke CASS stratification of firms).

Prohibiting the Use of General Liens in Custodian Agreements

Some firms in the UK appear to have inappropriately allowed custodians and sub-custodians to include a general lien in contractual agreements. The FSA believes that liens covering liabilities unrelated to the assets in question or the company that placed the assets with the custodian or sub-custodian have contributed to significant delays in insolvency practitioners recovering assets. Accordingly, the FSA has proposed prohibiting the use of certain liens in custodian agreements.

The consultation period ended on 30 June 2010 and the policy statement containing the final rules is expected during Q3 2010.


If you are a CASS firm, now is a good time to review your current client money arrangements to ensure that you are compliant with the applicable rules and are in a position to accommodate any changes that are likely to be required. CASS firms should consider the following.

  • Reviewing systems, controls and processes surrounding client money to check whether the firm is compliant with the CASS rules, especially if the firm has undergone a period of change and/or restructuring.
  • The appropriateness of the frequency that the firm prepares its client money and custody asset reconciliations by taking into account the risks to which the business is exposed, including the complexity of the business in addition to the nature and volume of transactions.
  • Whether appropriate systems are in place to facilitate the preparation of the CMAR and any potential changes to existing systems that may be required.
  • Who to appoint to the CASS oversight controlled function. In large and medium CASS firms (based upon a bespoke CASS stratification of firms) this will need to be a director or senior manager. In small CASS firms this will need to be a director.
  • Revising agreements with custodians to remove any non-compliant lien provisions that may be included.

The FSA's Client Money & Asset Report published in January 2010 and the findings and concerns within it, taking action where necessary.


Natasha Lee looks at the new regulatory structure coming into place under the Coalition Government, and the impact it could have on your organisation.

In his speech at Mansion House on 16 June, the Chancellor of the Exchequer, George Osborne, finally announced the Coalition Government's decision to abolish the FSA and replace it with the following structure.

  • A Prudential Regulatory Authority (PRA), which will carry out the prudential regulation of banks and insurance companies. This will be a subsidiary of the Bank of England, which will be led by the returning Hector Sants.
  • A Consumer Protection and Markets Authority (CPMA), which will be responsible for all conduct of business regulation and will include those firms which are regulated by the PRA.
  • A Financial Policy Committee (FPC), which will be responsible for financial stability, with power to direct the PRA, where appropriate.

More surprisingly, George Osborne also announced that Hector Sants agreed to remain as chief executive of the FSA until its demise in 2012, overseeing the transition to the new regulatory body, which he will subsequently head up.

Following the Chancellor's speech, on 26 July, the Financial Secretary to the Treasury, Mark Hoban, launched the Government's consultation on the implementation of reforms to financial regulation. The consultation period runs until 18 October 2010.

The document sets out the Government's plans to change the regulatory system, giving power to the Bank of England over macro prudential regulation through the FPC, which will be set up on an interim basis with effect from the autumn of 2010. In addition, the document invites responses to the Government's proposal on establishing a PRA and a CPMA as detailed above.

The document and feedback process can be found at

Finally, Sir John Vickers, a British economist, has agreed to chair an Independent Commission on Banking. The Commission will make recommendations that will:

  • reduce systemic risk in banking
  • mitigate moral hazard in banking
  • minimise potential and impact of banks
  • failing
  • promote competition within both retail
  • and investment banking.

The commission has also been tasked with the Government's wider goals surrounding financial stability and how the banking sector impacts on this. The commission will produce its final report in September 2011.

To date, few fully understand the impact of the proposed regulatory reform. There is a risk that the FSA will now go into limbo until 2012 as its employees consider how they will fit into the new regime or, as evidenced by certain recent senior departures, some are not willing to wait to find out. Meanwhile, firms face uncertainty over how regulation (including cost) will specifically change on a day-to-day basis and where they fit in this new era. There is also a risk that the remit of the PRA will be too wide, with too much focus being placed on banks, while broker-dealers and insurance firms suffer the consequences.


We clarify the reverse charge rules and highlight some points you may need to be aware of when processing payments.

The reverse charge is a fairly simple concept: where a business buys a service from outside the UK, and the service would have been subject to VAT if supplied by another UK business, the buyer has to account for VAT. If this were not the case, the tax would be too easy to avoid. In the financial sector, where many businesses can recover little or none of the VAT they incur, this can be a significant cost – especially when they get it wrong. Here are some pointers that might help keep you out of trouble.

  • Technically, the reverse charge is deemed to be a supply of services both by and to the recipient. The buyer therefore has to account for output VAT and then apply the partial exemption rules to calculate how much can be recovered as input VAT. One dangerous side-effect of this mechanism is that the notional supply by the purchaser counts as taxable turnover, which can take the business over the VAT registration threshold even if all of its day-to-day business activities are VAT-exempt.
  • The reverse charge now applies to virtually all services supplied from overseas, but not if they would have qualified for exemption within the UK. So if the supplier is another financial sector business, it may be worth looking behind the invoice and making sure that you have a full description of their work.
  • Bear in mind that the VAT definition of a service encompasses any transaction that is not a supply of goods. The reverse charge therefore applies to various forms of intangible rights, intellectual property, software licences and similar costs as well as the more obvious services such as advice.
  • Charges from associated companies are often overlooked. Supplies of staff, IT support services, and head office 'management charges' are all liable to the reverse charge even if no invoice is issued and – potentially – even if no payment is made.
  • At present, UK law disregards services supplied by companies within a VAT group registration, but even this is at risk. The European Commission takes the view that a VAT group is a separate taxable person from any of its member companies, and thus that supplies from overseas branches of group members are taxable. The UK (along with another seven member states) now faces infraction proceedings at the European Court of Justice. If the Court agrees with the Commission that our grouping rules are too generous, these services will also come within the scope of the reverse charge.

With the VAT rate about to go up, and heavy penalties for businesses that fail to take 'reasonable care', this is a good time to check that your business is handling the reverse charge correctly.


The landscape has changed for those wishing to establish a fund in the UK. Amendments to the tax regime applying to UK funds, combined with other corporate tax changes, has made it a prime location to domicile a fund.

The UK has always been an attractive location to establish a fund from a non-tax perspective, due to its well developed and business friendly legal, regulatory and control framework. In addition, the UK has always had a particularly extensive network of bilateral double taxation agreements (DTAs) (with more than 100 countries) which means that withholding taxes suffered on dividends earned globally can often be lower than other fund locations.

However, these factors were often outweighed by the UK's tax regime applying to funds.

Following extensive consultation between the Government and the financial sector, the tax regime for UK funds has been changed, while at the same time there have been other positive developments to the UK's taxation of foreign profits. Most of the changes come with conditions, in particular for funds, the requirement for diversification of ownership and distribution of income. However, for most funds, this should not be a problem.

These changes make the UK broadly comparable to other 'good' locations from a tax perspective, arguably making it a very desirable location to establish an investment fund all things considered.

We have briefly outlined the changes to the tax regime below.

Taxation of Dividends Received

From 1 July 2009, most dividends received by an open-ended investment company (OEIC) or authorised unit trust (AUT) are not subject to UK corporation tax in the fund. This will significantly reduce or eliminate the tax payable by a fund investing in equities and make such funds comparable to non-UK funds in most cases.

Capital v Trading Transactions

Capital gains have been exempt from tax in OEICs and AUTs for years. However, there has always been a degree of uncertainty over whether a transaction would be regarded as a capital or trading transaction. To deal with this uncertainty, HMRC has issued a comprehensive list of instruments, the investment transactions in which will be taxed as investment activity and not trading activity, the so called 'white list'. For the white list to apply, the fund must meet 'equivalence' and 'genuine diversity of ownership' conditions. Funds meeting the conditions will therefore have a high degree of certainty that they will be exempt from tax on their capital gains on white list transactions.

Property Authorised Investment Funds

The property authorised investment fund (PAIF) tax regime was introduced on 6 April 2008 and provides for tax-efficient investment into property through an authorised investment fund structure and is comparable to the real estate investment trust (REIT) regime applying to corporate structures (which was introduced on 1 January 2007). Subject to satisfying the conditions, the fund does not pay tax on income received. As with REITs the tax liability is passed to the investor. The PAIF regime therefore ensures that tax exempt investors do not suffer taxation in the fund that cannot be recovered.

Tax Elected Funds and Funds Investing in Non-Reporting Offshore Funds

The tax elected fund (TEF) and funds investing in non-reporting offshore funds (FINROF) regime now provide increased flexibility to transfer the liability for income tax from the fund to the investor, potentially reducing the risk of lost tax, particularly for non-taxpaying and non-UK resident investors.

Funds that do not satisfy the investment conditions to be treated as 'bond funds', but that satisfy certain other conditions, including genuine diversity of ownership, can now elect for TEF status and treat part of their distributions to investors as being tax deductible in the fund in a similar way to 'bond funds'. This element of the distribution will be treated as a payment of yearly interest and may have to be paid net of tax. This effectively passes the liability for tax on that element of income from the fund to the investor.

For accounting periods commencing on, or after 6 March 2010, UK funds with more than 20% of gross assets invested in non-reporting funds will be taxed as FINROF. Responsibility for tax on fund performance (as an offshore income gain) shifts from the fund to the investor. UK funds with 20% or less of gross assets invested in non-reporting funds can elect to be treated as FINROF.

The advantage of this tax status for a nontax payer or non-UK resident should be no UK tax liability, however the implications of FINROF status for tax paying UK investors will need to be considered.

In Summary

These recent changes make the UK a much more attractive regime to domicile a fund. Taking into consideration the tax and non-tax advantages noted above, the UK should be considered as a location of choice for many investment funds.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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