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Charged atmosphere

In the sixth part of a series on the IFA Guide to Working With Accountants and Solicitors, Sifa managing director Ian Muirhead looks at building fee-based client relationships

The difficulty many IFAs experience in making the transition from commission to fees often relates to their mindset, which is likely to have been product-oriented. Advisers will have been accustomed to looking for opportunities to sell products in order to generate commission.

However, trying to convince clients that they should pay someone a fee for trying to sell them a product is bound to be an uphill task.

Professionals’ clients, on the other hand, are used to paying fees for services. Consequently, before the adviser can switch from commission to fees, they must first switch from a product-based proposition to a service-based proposition.

The issue arises at the start of the client relationship. Many commission-driven advisers offer a free initial interview to attract potential clients and they use this interview to undertake fact-finding and to formulate recommendations, with fingers crossed that the client will agree to proceed.

However, this approach demeans the value of advice and encourages an aggressive sales mentality, because, if the client declines to proceed after the work has been done, the adviser will have wasted his time.

A better approach may be to present the fact-find data and the resulting recommendations and explanations to the client in a comprehensive report that can be seen to have an intrinsic value (and will incidentally provide a compliance audit trail). A charge can then reasonably be made for this report.

The adviser could take the opportunity at the initial client meeting of explaining the time and effort involved in this preliminary work and could make the point that, as a professional, they would need to be remunerated for this work. The adviser might then show the client an example of the type of report produced for other clients with a similar apparent need – perhaps investment, pensions, protection or estate planning – and offer to produce a similar report for a suitable fee. This fee would then be incorporated into the adviser’s terms of business, which the client would be asked to sign.

If a charge is to be made for the client report, the question of VAT needs to be considered. The principle stated in HMRC’s VAT information sheet 02/03 is that work which is ancillary to a VAT-exempt transaction of arranging an investment (such as fact-finding and research) will itself be eligible for VAT exemption, even if the proposed transaction does not take place, provided that the arrangements would have been the dominant element in the service provided so the charge for producing a client report would normally only be subject to VAT if it had been clear to the parties from the outset that no financial arrangements would result.

The client report could also suitably include provision for the client to request a regular investment review and report. Such a review is a vital part of the client relationship and provides the platform for the ongoing communication on which client goodwill is built. It would be remunerated by an annual retainer, probably payable by monthly instalments, and receipts of trail commission would be credited magnanimously to the client. Retainers will be subject to VAT, although HMRC has agreed that VAT need only be charged on the excess of fees over any commission receipts which are offset against them.

IFAs who, instead of offering a review service, prefer to concentrate on building their trail commission income by servicing only those investments which generate this form of commission, will have to tread carefully when formulating their terms of business because trail commission should itself be subject to VAT – although HMRC does not actually levy the charge, possibly because the cost of doing so would outweigh the revenue to be gained.

The reason for this apparent anomaly is that trail commission is paid not for the VAT-exempt service of arranging investments but for the non-exempt service of keeping an existing investment in place (trail commission must be distinguished in this respect from the deferred initial commission available on investment bonds, which does relate back to the original service of arranging.

Fee-based advisers need to explain to their clients the service for which they are being remunerated and if they try to do so in relation to trail commission they will be putting their heads into a VAT noose.

The solution would appear to be to insert in the terms of business an explanation that no VAT is charged (as opposed to being chargeable) in respect of work which gives rise to commission payments.

In fostering the personal rapport which is fundamental to an enduring client relationship, it is important that the IFA should accept personal responsibility for formulating the advice given to each client.

Delegating the task of making recommendations to paraplanners is unlikely to be successful.

Clients and their professional referers are entitled to expect the person with whom they have had face-to-face contact to be able to explain and stand by their rationale and only the person who has personally looked the client in the eye and read their body language can begin to understand the limits of their understanding and their likely receptiveness to the various alternative financial planning solutions which may be available.

John Chatfeild-Roberts, the award-winning fund of funds manager at Jupiter, refers in his book Fundology to the importance of seeing “the whites of the eyes” of fund managers whose funds are being considered for investment. The same applies to the interface between IFA and client.

The empathy of the IFA with the client will be reflected in the choice of language used in the client report and is an essential part of the bonding on which the future client relationship depends. Consequently, there is a strong argument for delegating to support staff only purely mechanistic tasks such as research and administration.

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