Investment management VAT update
We will cover:
- MiFID II research
- CJEU’s decision in BlackRock – VAT treatment of Aladdin portfolio management platform
- First tier tribunal decision in Melford Capital - VAT recovery for private equity fund
- HMRC consultations and working groups
- Brexit and the Specified Supplies Order
- Terminal Markets Order infringement proceedings
MiFID II research
Protracted discussions have taken place between HMRC and a number of industry bodies regarding the VAT treatment of fees paid by investment managers for research pursuant to MiFID II. HMRC’s current stance is that the provision of research is a standard-rated supply. As mentioned in our last update, Macfarlanes is advising on a case that challenges HMRC’s stance.
On Christmas Eve 2019 the Upper Tribunal released its decision in News Corp UK & Ireland Limited v HMRC, finding that digital versions of newspapers qualified for zero-rating. The tribunal reached its conclusion by applying the "always speaking" principle of statutory interpretation to legislation concerning printed matter as it stood at the time. HMRC have appealed the decision but in the meantime Group 3 of Schedule 8 of the VAT Act has been amended with effect from 1 May 2020 so as to explicitly afford zero-rating to electronic publications.
These developments raise the prospect of zero-rating for written research, which will account for the majority of the research consumed by many managers in terms of both value and volume. In fact when, before digitisation, it was the norm for research to be provided in print HMRC accepted that zero-rating applied. Macfarlanes is discussing the availability of zero-rating for MiFID II research with HMRC and we would be happy to share our insight with you.
It is important that investment managers review their agreements with research providers to ensure that they are in the best possible position to take advantage of zero-rating should it become available. This should include consideration of the supply position (for example, do the arrangements as they stand give rise to a risk that standard-rated research might taint research that would otherwise be zero-rated?) as well as the manager’s rights in respect of historical claims that might be made by the research providers against HMRC.
In practice it may well only be possibly to make changes to research agreements as part of a scheduled contract renewal. Many investment managers will undertake such a renewal in respect of all of their research providers once a year and for many managers the next renewal will come around at the end of this year.
The Court of Justice of the European Union (CJEU) has released its judgment in the case of BlackRock Investment Management v HMRC. The CJEU found that fees paid for use of the Aladdin portfolio management were subject to VAT in their entirety where the platform was used to manage qualifying special investment funds as well as other types of funds.
The case concerns services that were supplied via a software platform called Aladdin. The platform provided information to portfolio managers on every aspect of the investment lifecycle and enabled them to make investment decisions and monitor regulatory compliance. It was used by portfolio managers to manage funds that were special investment funds for VAT purposes (SIFs) as well as funds that were not SIFs.
The Aladdin platform was owned by a BlackRock entity in the United States, which supplied its services to BlackRock in the UK in return for fees that were largely calculated by reference to the value of assets under management. BlackRock UK self-accounted for VAT on the services under the reverse charge.
BlackRock argued that:
- supplies made by way of the platform were supplies of management for the purposes of the investment management VAT exemption; and
- the fees payable by BlackRock UK should be apportioned, with VAT due only on the part that was referable to the non-SIF usage. BlackRock did not dispute that the supply in question was a single supply but argued that an apportionment based on AUM should nonetheless be permitted.
The Upper Tribunal had earlier found that the services qualified as management but referred to the CJEU the question of whether apportionment should be permitted.
Rejecting BlackRock’s arguments concerning apportionment the CJEU found that the supplies were taxable in their entirety. The general rule was that a single supply of services must be subject to a single rate of VAT and there was no basis for departing from that rule in relation to the Aladdin services.
Furthermore the CJEU held that, contrary to statements made by the Upper Tribunal, it would not be appropriate to determine the single VAT treatment according to the nature of the majority of the funds managed, as this would have the effect of extending exemption to the management of non-SIFs (even if such funds represent a minority of the funds managed). This point was not directly relevant to BlackRock because the majority of the funds for which BlackRock used the Aladdin platform were non-SIFs. However, it will be relevant to other firms that predominantly manage SIFs and a question remains as to whether there might be a threshold below which any non-SIF usage is to be disregarded as de minimis.
Many investment managers will receive services from the same supplier in respect of both SIFs and non-SIFs. An example is fund administration services, which are capable of falling within the fund management VAT exemption as per the CJEU’s decision in Abbey National. In such circumstances agreements and systems will need to be in place that separate the services relating to the management of SIFs from those that relate to the management of non-SIFs. In considering such arrangements account should be taken of the AG’s statement in BlackRock that VAT exemption may apply where services provided specifically for SIFs are able to be identified "precisely and objectively".
It should be noted finally that questions were recently referred to the CJEU by the Austrian court in the case of DBKAG (C-59/20) on whether the granting of a right to use specialist software specifically designed for the management of special investment funds qualifies as a service of management for the purposes of the VAT exemption. Whether the CJEU will adopt a similar reasoning to the UT and conclude that such supplies do indeed qualify as management remains to be seen.
In Melford Capital General Partner Ltd a UK private equity fund was found by the First Tier Tribunal (FTT) to be entitled to full VAT recovery on its establishment and operational costs. We understand that HMRC have not appealed the decision.
The FTT reached its decision based on the specific facts of the case and, in particular, the way in which the fund and its assets were structured. Managers of UK based private equity funds should nonetheless consider whether they might be entitled to make a claim for VAT incurred in the past or whether there might be an opportunity to amend the way in which arrangements are structured going forward so as to improve their VAT recovery position.
The key facts in Melford were as follows:
- a UK manager was VAT-grouped with the UK general partner of a fund LP (VAT Group 1);
- below the Fund LP was an Isle of Man (IoM) holding company (IoM Holdco) and below that a number of IoM property holding SPVs (the IoM is effectively part of the UK for VAT purposes). The holding company and the SPVs were VAT-grouped (VAT Group 2);
- Fund LP funded IoM Holdco partly by subscribing for shares and partly by the granting of interest-free loans;
- IoM Holdco in turn funded the SPVs; and
- the UK manager supplied investment and administrative advisory services to the GP (acting on behalf of the fund) as well as to IoM Holdco and each of the SPVs. The UK manager charged each of the recipients for these services.
HMRC argued that:
- VAT incurred by the GP on establishment costs was irrecoverable as it related wholly to investment activities, which HMRC considered were not economic activities for VAT purposes; and
- VAT on operational costs had to be apportioned between the supposed non-economic investment activities and provision of the investment and administrative advisory services, and was therefore partially recoverable.
The FTT found that VAT incurred on both types of costs was recoverable in full. VAT grouping meant that the structure essentially involved two entities from a VAT perspective, VAT Group 1 and VAT Group 2. VAT Group 1 did not undertake any separate non-economic investment activities; all of its activities were economic activities because they involved the provision of services (investment and administrative advisory) in return for payment. Essentially the FTT saw VAT Group 1 as being analogous to a holding company and, based on the body of case law dealing with holding companies, found that it was entitled to full VAT recovery of its costs on the basis that it actively managed each of its "subsidiaries" (being the members of VAT Group 2) in return for payment.
The analysis applied by the FTT stands in contrast to HMRC’s long-held view of how the activities of private equity funds should be viewed from the perspective of VAT.
The decision presents opportunities, in particular, for any private equity fund that hold investments under a holding company outside its VAT group. This most often arises where non-UK investments are held under a non-UK holding company.
Read the full decision.
HMRC are consulting with industry on the tax (including VAT) treatment of asset holding companies as well as on a new notification regime for uncertain tax positions. HMRC will consult on the VAT treatment of fund management fees and a working group will examine the financial services VAT exemptions more generally.
In the Spring Statement the Chancellor announced a review of the VAT treatment of fund management fees, together with other aspects of the UK’s funds regime. The stated intention is to make the UK a more attractive location for the establishment of funds and asset holding vehicles. HMRC invited comments on the tax (including VAT) treatment of asset holding companies between 11 March and 19 August this year. However, due to Covid-19, we understand that a review of the VAT treatment of fund management fees is unlikely to take place this year. The Government has also announced the formation of a working group to examine the financial services VAT exemptions more generally.
Separately, the European Commission has commissioned a study on the VAT exemptions for financial and insurance services. The study will include a review of the fund management VAT exemption and the differences that currently exist between member states.
HMRC is also consulting on a proposed new notification regime for uncertain tax positions, which will include VAT, read our recent blog post.
Aside from the asset holding company consultation, little information has been given regarding the forthcoming UK VAT consultations but it will be important for investment managers to follow developments closely. Macfarlanes is involved in the various consultations and we will be happy to share our insight with you.
Following the end of the Brexit transitional period it is possible that VAT-exempt supplies of many types of financial services will give UK suppliers the right to input VAT recovery where the customer belongs outside the UK. Such supplies currently give the right to VAT recovery only where the recipient is outside the EU.
UK-based funds and fund managers may benefit from increased VAT recovery in relation to loans, disposals of credit instruments, arrangement fees, and equity disposals. The same benefit may arise for EU-based mangers and funds that transact with UK counterparties to the extent that reciprocal rules are introduced in the EU.
The legislation required to achieve the necessary changes in the UK - the Value Added Tax (Input Tax) (Specified Supplies) (EU Exit) (No. 2) Regulations 2019 (SI 2019/408) – was enacted last year and is to take effect on a day appointed by Treasury order.
On 14 May 2020 the CJEU issued its decision in the case of European Commission v United Kingdom of Great Britain and Northern Ireland (C‑276/19), finding that the UK has illegally extended zero-rating to certain transactions in commodities and commodity derivatives under the Value Added Tax (Terminal Markets) Order 1973 (the TMO).
The TMO provides zero-rating for certain transactions in commodities and derivatives that take place on markets listed in the TMO. Zero-rated transactions include those between market members as well as between a member and non-member. Where members of a market transact with one another as agents of non-members the services supplied by members to their principals are also zero-rated. The TMO also provides for an exception to the normal requirements to keep VAT records.
The list of markets contained in the TMO has changed over the years and the CJEU found that the UK did not make the necessary applications to the European Commission before adding the London Potato Futures Market, the International Petroleum Exchange of London, the London Meat Futures Market, the London Platinum and Palladium Market, the London Securities and Derivatives Exchange Ltd (OMLX), and the London Bullion Market.
The Commission also argued that if commodity options traded on the markets in question were not zero-rated then they should be exempt from VAT. The UK disputed this, apparently arguing first that the transactions should be standard-rated if they were not zero-rated and, secondly, that the question in any event fell outside the scope of the proceedings before the CJEU. The CJEU agreed with the UK on the second argument and therefore did not comment on what the VAT liability of the transactions should be if they were not zero-rated.
HM Treasury has issued a statement confirming that the CJEU decision will have no retrospective effect in the UK, that the government is considering its next steps, and that in the meantime the effect of the TMO remains unchanged.
Any future changes to the TMO could have an impact on funds that transact in products affected by the changes. The fact that Commission decided to commence infraction proceedings after the UK had notified its intention to leave the EU is interesting, particularly given that the offending changes to the TMO were made between the 1980s and early 2000s. HM Treasury is yet to provide any detail on what it proposes to do in response to the CJEU decision and developments in Brexit negotiations will almost certainly have a bearing on the path chosen.
Read the full CJEU decision.