VAT exempt investment management: funds equivalent to UCITS

The FTT has held that supplies of investment management services to certain types of charitable funds qualified for the VAT exemption for supplies to special investment funds (SIFs) based on the direct effect of Article 135(1)(g) of the Principal VAT Directive: CCLA Investment Management Ltd v HMRC [2024] UKFTT 636. The decision provides important guidance on how to determine whether a fund which is not a UCITS will meet the equivalence conditions for State supervision and appeal to retail investors.

However, it should be noted that the direct effect of Article 135(1)(g) has been removed in the UK by the Retained EU Law (Revocation and Reform) Act 2023 from 1 January 2024.

Background

CCLA provided investment management services to a number of different funds whose investors were charities, the Church of England and local authorities. Historically, these services were treated as subject to VAT, but CCLA later claimed a repayment of overpaid output VAT on the basis that their supplies qualified for exemption as fund management services provided to SIFs falling within Article 135(1)(g). HMRC rejected that application and CCLA appealed.

The supplies were to three different categories of fund:

• Charities Official Investment Funds (COIFs), established pursuant to a scheme of the Charity Commission and each a registered charity in its own right, with charity investors;
• Church of England Central Board of Finance Funds (CBFs), established pursuant to a 1958 Church Funds Investment Measure and each a charity in its own right, with Church of England entity investors;
• Local Authorities' Property Fund (LAPF), established pursuant to an HM Treasury scheme, with local authority investors.

CCLA argued that, although the funds did not fall within the UK VAT exemption provisions for funds in VATA 1994 Sch 9 Group 5 item 10, each of these funds were sufficiently similar to UCITS to qualify for exempt management services based on the direct effect of EU law at the relevant time (all of the supplies in dispute were made pre-Brexit).

FTT decision

The FTT noted that the principles on which the case was to be determined were largely agreed between the parties. These principles had been developed through CJEU case law. Essentially, all UCITS qualify as SIFs and other funds will qualify as a SIF if the fund has characteristics which are equivalent or sufficiently comparable to SIFs under the principle of fiscal neutrality.

The FTT noted that the principles determining when an investment fund that is not a UCITS will be equivalent to or sufficiently comparable to a UCITS had been usefully summarised in the EU VAT Committee Working Paper 936. These set out that other investment funds will only qualify as a SIF if each of the following conditions were met:

(a) the fund must be a collective investment;

(b) the fund must operate on the principle of spreading risk between investors;

(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;

(d) the fund must be subject to specific state supervision; and

(e) the fund must be subject to the same conditions of competition and appeal to the same circle of investors who would use UCITS.

It was accepted that conditions (a) to (c) were met in this case, but HMRC contended that neither conditions (d) nor (e) were met such that the funds were not SIFs.

State supervision

HMRC argued that for condition (d) (state supervision) to be met, it was necessary that the fund itself should be subject to state supervision (in the UK by the FCA as the Uk's financial regulator), not simply the investment manager. As none of the funds were directly regulated by the FCA, they failed this test.

The FTT has held that direct regulation of the fund by the FCA is not required for a fund to be eligible for the SIF exemption. Rather for a fund to be treated as a SIF, it must be subject to regulation that is sufficiently comparable to the regulation of the UCITS. For this purpose, regulation as an alternative investment fund (AIF) subject to Council Directive 2011/61/EU (AIFMD), would qualify as sufficiently similar. Although an AIF is not itself directly regulated by the FCA, it is indirectly regulated through the regulation of the AIF manager and the depositary.

In this case, the FTT noted that the COIFs and LAPF have been subject to a statutory scheme of regulation under the AIFMD since July 2014 and that statutory scheme was sufficiently similar to the regulation of UCITS.

However, in contrast, the CBFs were not subject to a statutory scheme of regulation. Whilst they had voluntarily chosen to apply similar requirements to those in the UCITS Directive, the voluntary adoption of such requirements was not sufficient to make them sufficiently similar to UCITS and those funds did not qualify as SIFs.

The FTT also noted that in this context, state supervision clearly requires financial services regulatory supervision. As such, supervision by the Charities Commission in this case was not sufficient, since the Charities Commission role was to supervise compliance with charity law and not financial regulation.

Equally, the FTT held that HM Treasury did not exercise any regulatory supervision of the LAPF. Whilst the scheme establishing the LAPF was approved by HM Treasury, its involvement with the LAPF thereafter ceased.

Same investors

As regards condition (e), in the absence of any evidence from investors as to the competitive nature of the market in which the funds operated, the FTT used its own experience to determine the question.

The FTT noted that the investment policies and objectives of a fund may be relevant to this question as they must appeal to the same circle of investors who would use UCITS ie retail investors. So a fund that does not target retail investors either due to its investment portfolio or because of conditions under which investors are entitled to participate, will not qualify as a SIF. For example, the FTT noted that more esoteric varieties of AIFs (such as commodity funds, hedge funds, infrastructure funds and private equity funds) are unlikely to appeal to retail investors. In addition, their investments are unlikely to be sufficiently similar to investments undertaken by UCITs.

In this case, the FTT accepted that the very great majority of charity investors in the COIFs are classified as retail investors. Investors in CBFs included Church of England parishes, dioceses, cathedrals, and other church charitable trusts. Many of these entities are small and are classified as retail investors. In addition, the FTT accepted that the terms of the scheme documents relating to the COIFs are sufficiently similar to the requirements of UCITS Directive that they appeal to the kinds of consumers who would invest in UCITS, and are therefore in competition with SIFs.

However, the FTT considered that the LAPF was not subject to the same conditions of competition and did not appeal to the same circle of investors who would use UCITS and as such the LAPF was not similar to, and is not in competition with, SIFs.

Conclusion

As a result of these findings, the FTT held that investment services to COIFs did qualify for exemption, but only from 2014 when such funds became subject to sufficiently similar State supervision. Investment services to CBFs did not qualify for exemption as these failed to meet the state supervision requirement and investment management to the LAPF did not qualify as the LAPF did not appeal to similar investors as UCITS.