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VAT implications of how and where you hold outsourced investments

Neil Jones, Canada Life technical project manager, on offshore bonds for discretionary management and the question of when and where VAT applies


Recently there has been a great deal of publicity around VAT and discretionary fund managers – or discretionary investment managers, as the FSA now refers to them.

A mixture of discretionary fund management and VAT conjures up a number of different discussions. Three immediately spring to mind:

  • The differing VAT treatment of offshore jurisdictions

  • Deutsche Bank in the European courts

  • The effect of VAT when recommending a DIM

Rather than look at just one, let’s consider each of these areas.

The DIM, the IRC and HMRC

When selecting a jurisdiction there are a number of factors to take into account.

One area that has seen discussion is around the use of Dublin-based investment bonds when utilising the services of a DIM for a UK investor.

Of course, it is assumed that it will have been determined, through advice, that the DIM is most (tax) suitably accessed via an offshore bond for the particular investor.

That said, where a UK policyholder appoints a DIM to manage the underlying investment, they will charge a fee. The invested assets will be owned by the life company and therefore the contract for services will be between the Irish-based provider and the UK-based DIM. The Irish government has deemed this not to be chargeable to VAT. This contradicts HMRC’s stance.

Under the EU VAT directive there is a VAT exemption for managers of special investment funds. However, and this is key, it is up to each individual member country to define what a special investment fund is.

The Irish Revenue Commissioners’ long-standing belief is that this exemption may apply to the services performed by a third party in respect of investment and the administrative management of a fund. This would therefore catch the mandates given to DIMs by Irish-based insurance companies.

By why does HMRC not interpret it in the same way?

HMRC initially limited the definition and therefore the exemption to unit trusts, OEICs and trust-based schemes. The list was expanded in 2008 to include close-ended investment trusts following the Claverhouse case.

This ruled that, while member states had discretion in defining special investment funds, they must consider the purpose of the exemption and fiscal neutrality.

From this explanation you can clearly see that there is not fiscal neutrality across EU member states. HMRC believes its interpretation is correct, as do the IRC.

So, where to now? Any review will take years to resolve and who knows what the resolution will be, but there needs to be consistency.

Whatever happens, this issue only arises when using a DIM and is only one consideration for selecting a jurisdiction for an investment.

Deutsche Bank; I was defeated you won the war

Initially some commentators felt that the Deutsche Bank case would help settle the Dublin VAT issue explained above. This is not the opinion of the IRC as they believe it refers to a different precedent. So, let’s consider what this case involved.

Deutsche Bank ran discretionary portfolios for investors and this included the management and administration, maintaining the holdings within a prescribed mandate without reference to the individual investors. For this service it charged 1.8 per cent of the value of the portfolio.

This fee was broken down into a management fee of 1.2 per cent covering the investment decisions and an administration fee of 0.6 per cent covering the cost of buying and selling the securities.

In May 2008 when the Bank completed its provisional VAT return, it declared the portfolio management services as VAT exempt. It felt that it was providing a combination of advice, execution and administration, exempt under the VAT directive as ‘transactions in shares and other securities’.

The Finanzamt (the German tax authority) took a different view, claiming the service was advisory in nature and that clients would be buying the investment expertise of Deutsche Bank. So they decided to settle this through the courts.

The European Court of Justice ruled in 2012 following an announcement by the Advocate General, Eleanor Sharpston.

She felt that when the services are combined, even though they can be separately identifiable, the client is buying a single service. And due to the nature of the overall service, VAT should apply to the whole fee.

This surprised some people who felt that VAT may apply to the advice and not the administration. The subsequent ECJ ruling followed her recommendation.

Recommending a DIM

Most will be aware of what the FSA is trying to achieve with the retail distribution review. However, the changes have consequences, the recommendation of DIMs being one.

The fees for providing financial advice are VAT-able, but the fees for arranging a financial product are exempt as intermediation.

HMRC has issued guidance on the interaction between the two; however, the recommendation of a discretionary manager is VAT-able, so if there is advice and a recommendation for a DIM, then the whole fee is potentially liable to VAT.

This is clearly a very important issue to the sector given the growing adoption of outsourced investment management by advisers. Advisers would, of course, be looking to ensure that all of the fees they charge in an advisory relationship were VAT exempt if the advice incorporates intermediation.

HMRC has announced a consultation on this and, whilst the results are expected before Christmas 2012, it is unrealistic to expect any implementation before the RDR, so we can expect a transition period into 2013.

Each one of these topics could be an article in their own right and go into a lot more detail. So when someone starts talking about DIMs and VAT then think about which aspect they are discussing and if there is an interaction between the different areas.

Neil Jones is technical project manager at Canada Life Limited


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