UK: A Review Of Financial Regulations And Tax Issues For FSA-Regulated Businesses

Last Updated: 19 November 2009
Article by Giles Murphy

Surveying the damage – one year on


How is the sector coping in the recession?

As part of Smith & Williamson's continued commitment to the financial services industry, we are conducting our 12th annual survey of the sector at a time of uncertain economic recovery, both in the UK and globally.

Last year's annual survey was conducted in the thick of the credit crunch following the collapse of Lehman Brothers, which was evident through our survey's findings.

A year ago, London's financial services industry revealed a fall in business confidence, with 56% of respondents reporting a drop in profit margins and one in four businesses expecting to make redundancies. Furthermore, in light of the credit crunch, 62% of participants believed that London's reputation as a financial centre had fallen since the year before.

The survey also revealed a fall in business confidence for the first time in five years, with 44% of respondents stating that confidence in their business prospects had fallen over the past year. This was in contrast to 2007, when 49% revealed they were reasonably confident and only 18% were not.

In addition to profit margins and confidence, 67% of firms were expecting either stable or decreased turnover, a stark contrast with 2007, when 82% of firms were expecting an increase in turnover.

Unsurprisingly, in light of the downturn, discretionary expenditures such as marketing were expected to be cut, with more than half of the respondents supporting this action.

Last year, changes to tax legislation raised little debate, with the majority of firms expecting no impact on their firm. In light of the last Budget announcement we do not expect this sentiment to still be held, in particular with higher rate tax payers, many of whom operate within the financial services industry.

95% of firms expected regulatory compliance costs for 2009 to remain stable or increase. Given heightened supervisory action coming from the Financial Services Authority (FSA) over the course of the past 12 months this view is expected to strengthen.

In light of last year's survey results, and the uncertainty surrounding the recovery of the global economy, it is important to assess the current levels of confidence within the financial services industry. Only in September 2009, central bank chiefs from both sides of the Atlantic announced that, in their view, the recession was over, although such a declaration came with a 'highly uncertain' warning sign relating to its strength and longevity. It will be interesting to see whether London's financial services industry shares these views.

Our survey is a reliable source of information relevant to your sector and highlights key areas affecting your market and business. We would like to invite you to participate by completing the enclosed survey. All participants will receive a full summary of our survey findings, which we hope will provide a useful benchmark of industry sentiment.

Individual responses are treated as confidential.


What should you be doing when the FSA comes to call for an ARROW visit? We offer tips and advice to help you through the process.

An advanced, risk-responsive operating framework (ARROW) allows the FSA to identify and measure the risks that firms, events and issues pose to its statutory objectives and to mitigate and monitor those risks on an ongoing basis. Consequently, it allows the FSA to determine where it should focus its supervisory resource.

Within the ARROW, there are two supervisory approaches adopted by the FSA to monitor firms.

  1. ARROW firms approach – used to assess individual firms (referred to as 'vertical' supervision).
  2. ARROW themes approach – used to assess cross-cutting risks; those involving several firms or market-wide (referred to as 'horizontal' supervision).

The purpose of an ARROW visit

The FSA performs a preliminary risk assessment on every regulated firm using its scoring system of low, medium low, medium high and high. To make this risk assessment, the FSA will use its ARROW risk model, which is illustrated in figure 1. The outcome of this assessment will determine the nature and extent of supervision a firm will receive from the FSA.

Always be prepared

In advance of its visit, the FSA will issue a firm an information request list which may include requests for documents such as business plans, compliance and internal audit reports, and risk management and financial information. The firm must ensure the information requested is made available at the start of the ARROW visit.

In support of this, the FSA will also arrange an interview programme specifying who they wish to meet with and the areas for discussion. As part of the preparation process, the firm should consider performing role plays with those to be interviewed so that they are fully prepared for anticipated questions and comfortable with an interview environment.

Both of these areas will provide a firm with strong indications of the focus for their impending ARROW visit.

We recommend that a firm establishes its own ARROW team, and/or principal contact responsible for liaising directly with the FSA on the ARROW process, to ensure it runs more smoothly – from at least the firm's perspective.

Many businesses also appoint independent firms, such as their auditors or compliance consultants, to perform a health check so that any areas which require updating can be addressed in advance of an FSA visit.

How to handle the ARROW visit

Hopefully, a firm will reap the rewards of its preparation during the FSA's visit. However, a firm may also wish to consider taking some or all of the following steps during the ARROW visit.

  • Consider using note-takers during the interviews. This can be a useful aide to subsequent interviewees as well as providing a reference for any issues which may arise at a later date.
  • Hold internal project meetings at the end of each day during the ARROW visit to ensure the firm manages its deliverables and assesses its progress.
  • Seek informal feedback from the FSA at the end of its visit.

Once the FSA has left

Following the ARROW visit, the FSA will seek a formal 'close-out' meeting with the firm prior to issuing its findings in writing.

The FSA will send its ARROW letter to the firm's board of directors, detailing the following:

  • key findings
  • the firm's main risks and controls
  • the FSA's risk assessment process and risk rating of the firm
  • Risk Mitigation Programme (RMP).

The RMP is driven by the FSA's risk assessment of the firm and details actions designed to help it achieve certain regulatory outcomes.

The firm is required to confirm the factual accuracy of the letter as well as its adherence to the RMP and its related timetable. It may challenge the factual accuracy and timetable with its supervisor, but no or inadequate action is not an option as it will only lead to more onerous, if not potentially fatal, supervision for the firm. You have been warned.


High earners should take action now to fully utilise their special allowance pension contributions.

In the July edition of the FSMG newsletter, we discussed the proposed increases in income tax and national insurance over the next two years. We also looked at proposals to limit tax relief for pension contributions made by high earners from 6 April 2011. We now examine that proposal in more depth.

As a reminder, it is proposed that from 6 April 2011, tax relief on pension earnings will be restricted to the basic rate for those with taxable income of £150,000 or more. Some form of tapering is promised for those with income between £150,000 and £180,000.

In anticipation of this forestalling provisions have been introduced to prevent high earners boosting pension contributions in the interim. Broadly, in both 2009/10 and 2010/11, individuals with income in that year or either of the two preceding years of £150,000 or more, who pay more than the special allowance of £20,000 in pension contributions, will be limited to tax relief at 20% on the excess contributions.

This allowance will apply to both company and personal contributions. The amount of relief can however be increased in the following two circumstances.

  1. Where regular monthly or quarterly contributions have been made on behalf of an individual, and continue to be made after 6 April 2010, at the same level or on a similar basis.
  2. Where irregular contributions have been made in the three years to 5 April 2009, the average of those contributions, capped at £30,000.

If there is a mixture of regular and irregular contributions then the deductible amount will need to be calculated with great care.

In calculating the income for the purpose of limiting tax relief, pension contributions of up to £20,000 can be taken into account. For example, provided the income limit had not been breached in the two preceding years, an individual with income of £169,000 and paying a one off pension contribution greater than the special allowance of £20,000 would not be regarded as a high earner and could therefore obtain full tax relief on the total contribution, up to the amount of their earnings.

In contrast, someone earning £171,000, with no past history of pension contributions, would be a high earner as their taxable income would be £151,000 after deducting the allowable first £20,000. That individual would only receive higher rate tax relief on pension contributions up to £20,000.

Consideration should be given to utilising the available higher rate tax relief while it remains available. However, careful planning is needed by high earners considering pension contributions over £20,000.


A review of mixed supplies could lead to dealing commission becoming subject to VAT.

Many businesses in the financial sector supply both taxable and exempt services, often to the same clients. If the client is unable to recover the VAT the business may be tempted – or put under pressure – to lean heavily towards the exempt aspects of the services. HM Revenue & Customs (HMRC), of course, approaches such questions from the opposite direction; it expects the exemptions to be interpreted narrowly and every so often an issue erupts where the 'industry practice' is shaken up. Currently, the focus is on investment management.

Private client fund managers will probably be aware that the VAT treatment of their charges is under review. HMRC is saying that commission charged under a discretionary fund management agreement should normally be subject to VAT, along with the annual management fee. In its view both charges relate to a single, VATable service, but most fund managers currently treat the dealing commission as exempt.

The correct answer, as is often the case with VAT questions, is that it depends. If the dealing commission genuinely represents a separate supply of services then it must be exempt, but if it is merely part of (or 'ancillary to') the fund management advice then HMRC could be right. If you have not already done so, you should check the wording of your contracts and client correspondence to determine whether you have an exposure.

Smith & Williamson is following developments closely and expects HMRC to clarify its views in the next few weeks. It remains to be seen whether HMRC will apply its preferred treatment retrospectively and raise assessments.

HMRC has also suggested that VAT should be charged on introductory fees charged to fund managers; again, strictly, the correct answer depends on what exactly is being introduced and it is not clear whether this indicates any change of policy by HMRC. However, this has always been an area where transactions can be interpreted in different ways and if you receive or pay introductory fees you should make sure that the VAT treatment has been properly considered.

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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Giles Murphy
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