Codifying the VAT exemption for fund management

The government has published a consultation document setting out its plans to codify the definition of the existing VAT exemption for the management of special investment funds. VAT treatment of fund management services: Consultation contains a technical consultation detailing proposed reform of the legislation that provides for the VAT treatment of fund management which runs until 3 February 2023.

In essence, the government intends to replace the existing definition with one that will not require reference back to EU law and jurisprudence, providing a clean and simplified rule allowing investment managers to determine whether they fall within the exemption with greater certainty. The proposed approach is expressly intended not to amount to a change in policy on the scope of the current VAT exemption (nor, indeed, does it address other matters such as industry requests for zero rating of fund management services to support the UK as a competitive jurisdiction for asset management).

Background

In February 2022, HM Treasury (HMT) published its much anticipated Summary of responses to its January 2021 Call for Input, Review of the UK Funds Regime.

From a tax perspective, the top priority item identified by respondents was the review of the VAT treatment of fund management, specifically to ensure that the treatment of fund management in the UK is competitive, uncertainties and complexities are addressed and importantly that the case for zero-rating is considered.

The response document confirmed that the government would “shortly” publish a long-awaited consultation on the VAT treatment of fund management fees. However, disappointingly given its importance to the competitiveness of the UK funds market, the response document ruled out (at that stage) the possibility that the further consultation would consider the possible introduction of a VAT zero-rate for fund management fees for fiscal reasons, and given the assumptions made by HMT as to the Exchequer cost. The consultation also avoids commenting on model portfolio services, which may leave many in the industry feeling that the most complex and divisive issues are not being properly addressed by HMRC.

Consultation

The new consultation is limited to the proposal to codify current UK policy for the VAT treatment of fund management into UK law without significantly changing the law. This legislation would establish the VAT liability of a supply of fund management without requiring reference to other sources of case law and guidance with the aim of providing certainty and clarity and simplifying the process of determining whether the exemption applies.

The current legislation is contained in Items 9 and 10 of Group 5 Schedule 9 VATA 1994. However, determining the application of the rules also requires reference to EU law and jurisprudence in addition to the UK provisions and case law.

The government now intends to:

• retain the list of exempt fund types currently comprising Items 9 and 10. This aims to support the UK fund management industry that currently utilise these provisions where the funds in question may not meet the new SIF criteria. However, it is not intended that this list of exempt fund types will be expanded in future. Items 9 and 10 are retained purely to ensure continuity of treatment for existing funds.
• make legislative changes to bring relevant case law and guidance into UK law to provide certainty in VAT treatment of fund management by establishing defined criteria to determine which funds are entitled to the SIF exemption, alongside the existing list of fund types in VATA.

Under the second element of this approach, the following criteria for a fund to be considered a SIF would be legislated for:
a) the fund must be a collective investment (broadly defined in line with the Financial Services and Markets Act 2000);
b) the fund must operate on the principle of risk-spreading;
c) the return on the investment must depend on the performance of the investments, and the holders must bear the risk connected with the
fund; and
d) the fund must be subject to the same conditions of competition and appeal to the same circle of investors as a UCITS (Undertakings for
Collective Investment in Transferable Securities), that is where the fund is intended for retail investors.

In particular, and in a departure from EU law and the conclusion in Fiscale Eenheid X, the proposed definition would not require that funds qualifying as SIFs must be subject to ‘State Supervision’. The government proposes to drop this criterion as part of the legislative reforms. To an extent, limb (d) may require some level of regulatory oversight in practice, given restrictions on how collective investment arrangements may be marketed and made available to UK retail investors. For example, it seems likely that non-UK funds that are within the scope of the FCA’s Overseas Funds Regime (when this goes live) would meet this element of the SIF definition.

The consultation explains that: “This approach would provide a consolidated single source of law regarding the VAT liability of a supply of fund management. It seeks to significantly reduce the administrative burden on all stakeholders by simplifying the decision-making process and reducing the time and resource currently required to identify the VAT liability of a supply of fund management. It also ensures that all relevant laws are within UK statute, removing reliance on EU legislation or guidance. This approach aims to reduce ambiguity and the scope for differing interpretations of law and case law by providing a stable legal basis on which businesses can operate. It should reduce the amount of litigation which takes place in this area, which is a significant burden for all stakeholders involved.”

Comment

This consultation will run for eight weeks and will close on 3 February 2023. Responses should be submitted electronically to
HMTVATandExcisePolicy@hmtreasury.gov.uk.

Although positioned as simplification of the current regime, the proposed consolidation will provide less clarity than zero-rating, and this may inhibit the UK’s desire to be seen as a jurisdiction in which to domicile investment funds and other vehicles, particularly where those funds and vehicles are managed domestically with the UK based investment manager suffering input VAT restriction that may not apply where a non-UK vehicle is involved that is not intended for retail investors. Certainly the proposal is somewhat underwhelming given the delay in producing the consultation which was promised back in February 2022, although it may be that discussions on broader reform will continue in the background.