VAT, research and MiFID2

HMRC has released long-awaited final draft guidance on the VAT implications of the implementation of MiFID2 and, in particular, the requirements to unbundle and separately charge for research services, either from the investment manager’s P&L or via a Research Payment Account. The guidance confirms that these requirement to unbundle and charge separately for research means that, whichever payment model is adopted, investment research will typically attract VAT at the standard rate following implementation in January 2018.

However, in the case of management of special investment funds, research can in appropriate cases form part of the management service such that research services outsourced by the fund manager may fall within the exemption from VAT for fund management.

Background

The implementation of MiFID2 will have significant consequences for the delivery of investment research within EU financial markets. As an incidental effect of these changes, the VAT treatment of research services will also be affected.

Legislation implementing MiFID2 will introduce significant restrictions on the way in which research may be provided, with a view to enhancing transparency and investor protection. In particular, investment firms will need to make explicit charges for research so as to demonstrate that persons are not being induced to trade. Accordingly, it will no longer be possible for investment firms to bundle research with execution services and, where various services are provided, it will be necessary to separately identify and charge for execution, research and any other services. These changes will be introduced from January 2018 and the November 2017 Budget forecasts that they are expected to raise around £40m per annum.

Current VAT position

At present, where research is merely ancillary to an execution service, it is possible for an investment firm to treat that bundled research as benefiting from the exempt VAT treatment afforded to the execution service, as there will be a single supply of execution services only from a VAT perspective.

In contrast, where the combined supply of research and execution, seen together, forms a discrete single supply of portfolio management, then that supply cannot qualify as an exempt transaction in securities. This is the case whether or not there is a separate periodic charge made for the execution element of the service. Execution service fees may still benefit from exemption, however, where they are charged on a transaction by transaction basis.

Clearly, however, to the extent that there will be an absolute requirement following MiFID2 to unbundle and charge a separate identified fee for research, questions have arisen as to the extent that the single supply treatment can continue (if at all). HMRC has been in dialogue with industry concerning these and related questions, including the extent to which research might fall within other relevant exemptions from VAT. For example, earlier ECJ case law in GfBK suggests that the exemption from VAT for the management of special investment funds (SIFs) can encompass delegated services performed by a third party providing advice on investments to the fund manager.

HMRC guidance

Following consideration of these issues, whilst HMRC initially has announced that it had concluded that it could not maintain the current treatment of research because under MiFID2 research services paid for by a client will be supplied separately from, and in no way linked to, execution services, the final draft guidance takes a somewhat more nuanced approach. In particular, the guidance retains the distinction between research supplied for a separate identified charge (which will be a taxable supply of research) and a single supply of exempt execution services to which advice is purely incidental. In this context, the guidance sets out the MiFID2 definition of research and stresses that it will normally involve provision of services which “explicitly or implicitly recommends or suggests an investment strategy” or “otherwise contains analysis and original insights and reach conclusions based on new or existing information that could be used to inform an investment strategy”. The implication appears to be that some limited forms of research may fall below this bar and may, therefore, still be ancillary to an exempt execution service. However, the guidance stresses that it is for the taxpayer to determine the VAT consequences of providing research and provides very little guidance as to where taxpayers may draw this particular line.

Nevertheless, it is clear that as a consequence of MiFID2 unbundling, many supplies of research will not give rise to separate, distinct supplies, regardless of whether these supplies are received and paid for by an investment manager or the investor client, that will not be covered by the finance exemption. There is no exemption for a supply of research and any argument that executing brokers would be able to link a taxable supply of research to an intended supply of execution goes against the separation principle introduced by MiFID2.

However, HMRC accept that the GfBK case indicates that research can be an element of a supply of fund management services. Where the relevant fund is a SIF, fund management services will be exempt from VAT. HMRC has, therefore, confirmed that research supplied as part of fund management services provided to a SIF may continue to qualify for exemption from VAT. This will be the case even where management services (including research) are outsourced, provided that the research received by the fund manager amounts to outsourced management.

Comment

Providers of investment research should now be considering their position under the new rules to be introduced. To the extent that they will be charging a separate identifiable fee for research, provision should be made to charge VAT on such amounts. Only where the research is provided to the manager of an SIF might such research fall within the exemption for fund management. In these cases, suppliers of research should make sure the research they provide is sufficiently connected to the management functions of the fund manager to qualify for exemption before accepting their supplies are exempt.

From the perspective of managers receiving supplies of unbundled research, it will be necessary to consider how that research is being consumed, and in particular the extent to which it relates to taxable or “outside the scope with recovery” supplies, in which case any VAT charged by research providers should be recoverable and therefore only amount to a cashflow cost at most. For managers that are wholly or partially exempt, such as managers that provided exempt fund management services to SIFs, a key question to resolve will be the extent to which the receipt of the research can be brought within the same exemption, applying GfBK.

Finally, the guidance does, however, continue to acknowledge that some advice or research may remain incidental to a supply of exempt execution services. It seems clear, however, that this will be limited to non-MiFID2 research of a general nature and that HMRC see it as the responsibility of providers of such services to determine the dividing line for both MiFID2 and VAT themselves.