Luxembourg: MiFID II And VAT: What To Expect

Last Updated: 1 December 2017
Article by Quentin Warscotte

Most Popular Article in Luxembourg, December 2017

In April 2014, the final text of the revised Markets in Financial Instruments Directive (MiFID II) was adopted. Almost four years later—including a one-year delay—the text should come into effect on 3 January 2018.

The aim of the first MiFID, applicable since 2007, was to establish a harmonised regulatory framework for the provision of investment services by banks and investment firms as well as for the operation of regulated markets. Even though the initial MiFID is widely recognised as achieving closer integration of the financial markets in the European Union, shortfalls in investor protection (including prevention of conflicts of interest) and market transparency remain.

According to the European Commission, MiFID II aims to address these limitations by (i) making financial markets in the European Union more robust and transparent and (ii) creating a new legal framework that both better regulates trading activities on financial markets and enhances investor protection.

My colleague Jan has already blogged about the consequences of MiFID II from a regulatory point of view.

Regulatory issues are an important aspect of MiFID II, but there will also be other, less obvious consequences, like the VAT impact on banks and investment firms, or the VAT burden borne directly or indirectly by investors. Having heard the takes of several Europe-established VAT advisers who have already felt MiFID II's effects, I'd like to explore the VAT consequences of the ban on inducements and the related unbundling of research and brokerage costs.

Ban on inducements

In order to improve transparency and investor protection, MiFID II will prevent portfolio managers and independent investment advisers from receiving third-party inducements. Such inducements often consisted in commissions (or non-monetary benefits) retroceded by various parties (often banks or fund managers) to investment professionals as a consequence of their clients' investments. MiFID II will also limit and frame the payment of inducements to other professionals (such as non-independent advisers or agents) by requiring that these amounts be paid in the best interest of the client and that they be linked to an enhancement in the quality of the service provided to the investors.

A possible consequence of this could be a decrease in the number of investment firms and intermediaries, which may not be MiFID II's intended purpose. Looking past that, however, will portfolio managers and independent investment firms end up raising their fees to investors? Will other investment firms update and broaden the scope of the services they offer, for example by conducting periodic assessments of investors' portfolios, profiles, and investment strategies? Simultaneously, non-independent firms and agents might end up limiting themselves to offering passive investments in their own products, meaning a shift from personal to collective management. These tendencies were particularly noticeable in the UK after a new regulation, the FSA's Retail Distribution Review, which mirrored MiFID II in terms of inducement, was introduced.

This paradigm shift will not, however, be VAT-neutral, neither at the level of the independent investment firms and portfolio managers nor at the level of the investors.

Like collective investment fund management, monetary inducements are generally VAT-exempt, since they are considered to be negotiation related to transactions in securities. However, personal financial advice or discretionary portfolio management rendered to one particular investor are subject to VAT, at the standard rate of 17% in Luxembourg.

On services offered by independent firms and portfolio managers, VAT-exempt inducements could be replaced by taxed commissions. This would affect the price paid by investors (which might already get substantially increased to compensate for the loss of inducements)—though would also positively affect the VAT deduction rights of private bankers and wealth managers. Considering that VAT is usually a significant charge for banks, this would at least be some good news!

Unbundling of research and brokerage costs

Currently, investment banks providing both execution services and financial advice consisting in macroeconomic, industry, or security-specific research usually charge one single price for the two (research fees being included in the commissions charged for settlement—or provided "for free"—triggering their qualification as inducement under MiFID II).

As such, this service pairing is generally considered VAT-exempt, on the ground that the research service, which is not priced separately, consists in nothing more than an ancillary supplement to the main service, or "a means of better enjoying the principal service supplied." VAT case-law foresees that, in such cases, the VAT treatment of the ancillary supplement (the research) should follow the exemption scheme of the main activity (the execution), which in this case is VAT-exempt.

However, MiFID II's transparency requirements, alongside the ban on inducements, imply that investment firms offering both execution and research services will have to provide and price them separately, enabling the application of the "best execution" principle, i.e. where customers may cherry-pick among research providers and brokers. It can also be expected that, going forward, research will be invoiced to the manager whereas execution will be charged directly to the fund.

Currently, research activities carried out by investment firms tend to be of a generic nature, unlike (VAT-exempt) investment advisory services rendered to investment funds which are tailored to each fund. As a result, it is widely agreed that isolated research services should be subject to VAT. In Luxembourg, this would often mean that the price of research carried out for the ultimate benefit of the investor will be increased by an irrecoverable 17% VAT.

Going forward, of course, the applicability of the above-mentioned financial advisory exemption may need reconsidering, as the scope and extent of paid research services could evolve. Tensions and limitations linked to regulatory aspects might appear—for example, research providers might not always get authorisation to act as advisers.


The above commentary is, I should mention, informed speculation. The extent of MiFID II's impact, on VAT and elsewhere, can only be thoroughly assessed when it's up and running. However, preparing for VAT developments might require actions sooner rather than later.

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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