VAT on fund management services: summary of responses

HM Treasury has published its long-awaited response to its consultation on changes to the VAT exemption for the management of special investment funds (SIFs). In essence, the government has responded to feedback to the consultation by confirming, despite the suggested approach in the original consultation, that it will retain its current, list-based approach to identification of the funds which fall within the definition of a special investment fund, accepting points made by respondents that a principles based approach would have introduced a greater degree of uncertainty.

Less welcome perhaps is the fact that the government has not decided to take up calls to provide a definition of "management" for these purposes and has, again, ruled out any prospect of introducing zero-rating for UK fund management services.

There is also no mention of model portfolios, although we are expecting separate guidance from HMRC in relation to model portfolios, in early 2024.

Background

At Budget 2020, the government announced a wide-ranging review of the UK funds regime, including tax and VAT, to take advantage of any opportunities provided by Brexit. In relation to VAT specifically, in December 2022, the government published a technical consultation which focussed on the definition of the VAT exemption for management services of SIFs, including options for improving the clarity and certainty of the legislation and removing reliance on retained EU law.

The consultation contemplated that the government would:

• retain the list of exempt fund types currently comprising Items 9 and 10. However, it was not intended that this list of exempt fund types would 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 Items 9 and 10.

For further details of the consultation, see our article "Codifying the VAT exemption for fund management".

Government response

The response document notes that respondents were appreciative of the clarity and certainty provided by the list based approach set out in Items 9 and 10 and would prefer the government to update those lists as new fund types emerged. In contrast, respondents highlighted areas of uncertainty that would arise with a criteria based definition of SIF going forwards. In particular, there were concerns over applying the criteria to non-UK funds and the resulting risk of litigation, especially concerning the questions whether a fund is subject to the same conditions of competition as UCITS and appeals to the same circle of investors.

As a result, the government has announced that, bearing in mind the strong preference among respondents to continue to rely on a single model based on Items 9 and 10, it accepts that a list based approach is most appropriate to provide the industry with legal certainty around the scope of the concept of a SIF.

The response document also notes that calls for a "wider definition of "management" was almost universal". Partly this concerned uncertainties around the meaning of "management", given the amount of litigation. However, it also included calls to include outsourcing and reflect the use of current technologies, effectively widening the scope of the exemption to partially automated or IT-enabled outsourced services.

Despite the universal calls for greater clarify, the government's response simply records its view that "the current position established by settled case law provides sufficient legal certainty". However, the response notes that the calls for greater definition in this area will be taken forward as part of the review of the guidance. This will not, of course, widen the definition of management to the provision, but it will be important to see what approach HMRC's expanded guidance takes to the type of an integrated trading portfolio management and risk reporting software used in BlackRock Investment Management v HMRC [2018] UKUT 415.

Finally, the response document again rejects proposals put forward to zero rate fund management to UK domiciled funds to increase UK competitiveness in terms of fund domicile.

Comment

If the proposals put forward in the December 2022 consultation were somewhat underwhelming given the delay in producing the consultation, then the response is equally if not more underwhelming, given the delay in the response appearing. Ultimately, the much delayed consultation and response have simply left the VAT exemption unchanged.  

Having said that, the "simplification" proposed would have provided less clarity and as such the retention of a list based approach is ultimately to be welcomed.  Questions, though, still arise in connection with the maintenance of this approach, in particular the ability of the government to keep up to date the list to deal with developments in the fund and regulatory landscape.  For example, consideration will need to be given to the current list in light of the overseas funds regime that is expected to come into effect in the UK in the first half of 2024, and which would enable a streamlined process for funds domiciled outside the UK to apply to the FCA for recognition to facilitate marketing to UK retail investors. 

In addition, the continued refusal to contemplate zero-rating 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.