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Excising the excise

In January, the Association of Investment Trust Companies and JP Morgan Fleming Claverhouse Invest- ment Trust jointly lodged an appeal in the VAT Tribunal against HM Customs and Excise.

This move initiated a legal test case to challenge the charging of VAT on the fees paid by investment trusts to external fund managers.

This is not a new issue as the AITC has been lobbying for some time against the Government&#39s discriminatory VAT treatment of investment trusts.

We have consistently called for the Government to create a level playing field between investment trusts and unit trusts/Oeics by extending the VAT exemption granted to the latter on their management expenses.

It is a very important issue for advisers and their clients, as this discrimination costs investment trust shareholders £30m a year.

This is down to the Government&#39s continued refusal to grant investment trusts the same VAT exemption as authorised unit trusts and Oeics, which we believe is in contravention to the European Sixth VAT directive.

This provides that “special investment funds” are entitled to an exemption from the VAT they would otherwise pay on the costs of outsourcing their portfolio management.

The UK Government has interpreted this entitlement to mean that only authorised unit trusts and Oeics are eligible for this exemption.

Despite carrying out essentially the same activities and competing in the same markets, investment trusts are arbitrarily not included.

Investment trusts represent the UK&#39s biggest stockmarket sector by number, with over 350 companies, and hundreds of thousands of retail investors have savings in investment trusts. The present situation is unacceptable.

The AITC is not alone in believing that this is unfair. Ron Sandler, in his review of retail savings, recommended that this inconsistency should be removed and stated that the VAT treatment of investment trusts, along with other tax distortions, confused consumers and restricted competition.

After the Sandler review, the AITC was encouraged when the Government issued a consultation paper which closed at the end of January 2003. But a year has since passed and the Government has failed to act. We would have preferred a political solution but we cannot wait forever while our members and their shareholders suffer from the wrongful application of VAT. The time has come to challenge this through the legal process.

The legal action carries one potential major advantage. If we win, we believe the claim on VAT will not only cover the future but will also be retrospective, going back three years.

Costs are an increasingly important factor in investment decisions. For stakeholder pensions and Cat-standard Isas, the Government has set a 1 per cent per year level of costs.

Investment trust investors are undoubtedly disadvantaged by the cost of VAT on management fees and tax distortions should not favour one product over another.

An investment trust investing in the UK with a management fee of 0.85 per cent should be cheaper than an equivalent Oeic or unit trust charging 1 per cent per year but the fact that the investment trust has to pay 17.5 per cent VAT on top means that the investor ends up paying 1 per cent.

The AITC is committed to changing the current VAT treatment of investment trusts. The test case has been launched with the help of JP Morgan Fleming Claverhouse investment trust and we expect the case to be heard by a VAT Tribunal in the autumn.

The impact of VAT on management fees is particularly severe for trusts investing in the UK and Europe.

Robert Walther, chairman of the £316m JP Morgan Fleming Claverhouse investment trust, which is a UK trust, explains: “VAT on management fees costs our shareholders in excess of £300,000 a year, a cost the company would not bear if it were a unit trust or Oeic. This is unfair and we are working with the AITC to secure an exemption from VAT for the long-term benefit of our shareholders.”


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