If you have ever wondered why IFA fees are treated differently from many other professions, it is because the European Union decrees VAT should not attach to the sale of insurance and financial services products.
The foundation of EU VAT law is set out in directive 2006/112/EC, with the exemp-tion for financial services at article 135. Schedule 9 VAT Act 1994 has enacted this into UK law. We also have case law from the European Court of Justice and our own courts.
Financial advisers have to interpose the British IFA system within the wider diktat of VAT law from Europe. The UK cannot make unilateral changes or introduce new laws for IFAs. Similarly, HM Revenue & Customs cannot interpret VAT legislation in a manner contrary to EU law.
In 2007, the European Commission declared the current VAT directive in need of revision and said there should be greater clarity as to which elements of financial services are exempt. It proposed some profound changes that, in my opinion, would make things clearer but these have not been adopted.
If we take VAT law and place into this the scope of the potential work undertaken by IFAs, we can see the problems.
If IFA work never made mention of a financial product, it would all be VAT-able. Conversely, if IFA work was simply placing investment products, it would all be exempt.
It is often said advice is VAT-able but intermediation is exempt. This is an understandable divide but misses the point. The law says anything that is intermediation is exempt and anything that is not intermediation is VAT-able.
This sounds pedantic but using the word “advice” blurs our thinking. The pivotal issue we need to agree with HMRC is what is intermediation.
One might argue intermediation is simply the arranging of a financial product but it means a lot more. A mediator stands between the parties to a financial product and intermediation means any activity that may alter the rights of the parties and could lead to a product being created, continued, altered or ended.
Equally, the provision of advice that reflects specialised knowledge of the financial product is mediation of it.
It is not necessary that a product be started or ended but that the activity relates to some form of mediation. This wider definition would mean any activity (advice) you provide in connection with a financial product is exempt, irrespective of whether there is a buy or sell transaction.
Only once the question of what is intermediation is properly answered can we start to understand what is VAT-able, what is exempt, what our taxable turnover is and where the predominance rule sits. We need VAT guidance that is fair and clear to comply with tax law and to establish and operate informed charging models.
I do not want to see the public face a 20 per cent increase in the cost of advice, nor do I want to see VAT influencing client actions – encouraging unnecessary moving of investments to show a product sale to avoid VAT or discouraging appropriate movement of investments because it has VAT-exempt trail commission.
We also need to prevent inconsistencies within the industry and at a local tax level.
HMRC will produce draft guidance later this year, which will then enter a period of consultation before final guidance is issued in 2012. If you have questions, now is the time to submit them to the various parties working on this or to us at fwd@ funds-network.co.uk.
We will not overcome VAT issues by using artificial tags, labels or contract conditions. VAT law works on the facts of what you do, not on what you say you do.
Paul Kennedy is head of trusts and tax planning at Fidelity International