UK: UK VAT Exemption For Fund Management Services

Last Updated: 19 November 2008

Changes to the scope of UK VAT exemption for fund management came into force on 1 October 2008.

HM Revenue & Customs (HMRC) introduced changes to the scope of the UK VAT exemption for fund management following the European Court of Justice (ECJ) judgment in JPMorgan Fleming Claverhouse Investment Trust plc (JPMC). This article considers some of the implications for the industry.

Last year, the ECJ held that fund management services supplied to investment trust companies (ITCs) should be exempt from VAT. It ruled that the restrictive treatment applied by the UK was in breach of the principal of fiscal neutrality. From this it was clear that other similar forms of investment vehicle should also benefit from the VAT exemption.

To comply with the decision, the UK exemption for fund management has been amended by Statutory Instrument 2008/1892, which came into effect on 1 October 2008. The scope of the VAT exemption will now be extended to include the following.

  • Funds similar to open-ended investment companies (OEICS) and UK authorised unit trusts (AUTs).
  • Other collective investment undertakings – although, in order for the exemption to apply:

    • he sole object must be investment of capital, raised from the public, wholly or mainly in securities
    • assets must be managed on the principle of spreading investment risk
    • all ordinary shares (of each class if there is more than one) or equivalent units must be included in the official list maintained by the Financial Services Authority (FSA) pursuant to section 74(1) of the Financial Services and Markets Act 2000
    • all ordinary shares (of each class if there is more than one) or equivalent units must be admitted to trading on a regulated market situated or operating in the UK.

The exemption will also apply to foreign equivalents of the funds, such as Dublinbased OEICS and Luxembourg Société D'investissement À Capital Váriable (SICAVs) that are managed from the UK.

HMRC has issued Business Brief 48/08 to clarify the legislation. The key points to note are as follows:

  • HMRC has acknowledged that the sub-funds listed on the FSA register do not necessarily correspond to the sub-funds that are marketed in the UK. It has therefore provided a list of other factors (such as 'distributor status') that should be considered in deciding whether the management of a sub-fund falls within the exemption
  • there is now a de minimis provision which requires a fund (or sub-fund) falling within the new classification of those funds attracting VAT exemption, that is not 'for the time being' marketed to UK investors, to be treated as not within the VAT exemption categories, where either:

    • less than 5% of its shares or units are held overseas by UK investors, or
    • where that fund has never been marketed in the UK.

The expanded guidance note also provides more information on how the new legislation affects the recovery of input tax.

Impact Of The Changes

Retrospective claims

By now, most fund managers will have lodged retrospective claims with HMRC to recover overpaid output tax. But a number of issues have arisen with regard to the backdating of these claims. The recent Condé Nast case established that the UK law to cap claims by three years was defective when first introduced in 1997, as no adequate transition period was provided for. As a result, fund managers are now entitled to file claims dating back more than three years, although we understand that HMRC is taking a rather aggressive line.

First, HMRC needs to be satisfied that the fund managers will not be 'unjustly enriched'. They are unlikely to approve claims unless it can be demonstrated that monies will be passed to the original customer, which is not unreasonable.

HMRC also requires that the claims submitted by fund managers be reduced to allow for input tax recovered previously.

Again, this is not unreasonable, but HMRC has also insisted on a further reduction in input tax which the ITC may have already recovered.

However, HMRC has been accused of acting unlawfully in this regard, since this requires one taxpayer to reduce his/her claim to allow for VAT that HMRC is unable to recover from another taxpayer. This could result in further litigation action.

Input Tax Restriction

To date, fund managers have been entitled to recover input tax (and not charge output tax) in respect of funds located outside the UK. This is on the basis that providing fund management services to a similar fund in the UK would be taxable. The new rules mean that where a fund is covered by the VAT exemption, the VAT recovery on related costs will need to be restricted. This will impact on a fund manager's cost base as the irrecoverable VAT cost will increase.

From a VAT compliance perspective, many fund managers will become partially exempt for the first time and will therefore need to negotiate a partial exemption special method. As a result of the change in business status from taxable to partially exempt, HMRC may be slow in approving the new methods.

Umbrella Funds

With respect to 'umbrella funds' such as SICAVs established in Luxembourg, HMRC requires that the VAT exemption be applied at sub-fund level, i.e. it is not the management of the SICAV, but the management of the SICAV's 'recognised' sub-funds that are exempt. However, there are likely to be practical difficulties in establishing which sub-funds are affected.

Pension Fund Management

Finally, it should be noted that the VAT treatment of pension fund management is also under review. A new case yet to be heard by the Tribunal will test whether the principles of the JPMC decision can be used to bring pension funds within the definition of 'special investment funds', and thus within the VAT exemption. If successful, this case could also have a retrospective effect, creating more work but also significant opportunities for those involved in this sector.

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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