New year brings UK VAT implications for fund managers (2024)

UK fund managers that have relied on a VAT exemption in relation to the services they provide may no longer be able to do so following a change in UK law that took effect on 1 January 2024.

That possibility was confirmed in recent communication from the government at the end of a lengthy period during which significant potential reforms to the tax environment for UK funds were explored.

The government first announced a review into the UK’s funds regime at the 2020 Budget. Covering both tax and regulation, its stated objective was to make the UK a more attractive location to set up, manage and administer funds, as well as to support a wider range of more efficient investments better suited to investors’ needs.

The ambition of that review has, however, diminished over time. This was reflected recently when the government issued its response to a consultation it had opened in late 2022 on the VAT treatment of fund management services.

The initial consultation paper set out proposed reforms in respect of how VAT applies to fund management services in the UK, but the Treasury was at pains to say at the time those reforms were "not intended to result in a significant policy change in VAT treatment for the fund management industry...".

The response paper published last month confirmed, however, that the government would not be taking forward even the limited changes it had consulted on – the introduction of a principles-based approach to the definition of a special investment fund (SIF) with specific UK criteria which could be applied.

Despite this, the response paper, together with a written statement issued by financial secretary to the Treasury, Nigel Huddlestone, did contain notice of a significant change in VAT law as it applies to UK fund management services. It highlighted the impact of the new Retained EU Law (Revocation and Reform) Act 2023 (REULA), which entered into force on 1 January 2024, and means that UK fund managers can no longer rely on the direct effect of EU law as it concerns the application of VAT to their services.

This is important in the fund management industry as the rules-based UK VAT exemption for fund management has not historically been drawn as widely as the principles-based EU legislation. This has led to various instances where the UK's list has been held to not be sufficient to encompass the wider EU definition, including the decisions of the Court of Justice of the EU (CJEU) in the cases of Claverhouse and Fiscale Eenheid X. These decisions have in turn led to an iterative process of revisions to the UK legislation to widen its ambit.

In the absence of the ability to rely on the direct effect of EU law, UK funds will now not be able to challenge the scope of the UK VAT exemption, meaning that the scope of the exemption may diverge between the UK and the EU.

The consultation response indicates that the government considered that the existing UK VAT legislation should cover the “vast majority” of fund types for which management should be exempt from VAT. This of course indicates that there are some fund types which the government considers would have been covered by the exemption on the basis of EU law but the management of which will not now be treated as exempt from VAT under UK law.

Late last month, the Investment Association distributed apparent new guidance from HM Revenue & Customs (HMRC) that indicates that at least some of these fund types, specifically model portfolio services, will continue to benefit from exemption based on an interpretation of the UK exemption legislation. That guidance has not been confirmed by way of a formal HMRC briefing note and nor has HMRC updated its own guidance. It is to be hoped that HMRC provide formal clarification on the matter soon so that all taxpayers have a full understanding of HMRC’s position in relation to these issues.

Fund types not specifically covered by the apparent new guidance will be seeking to rely upon the “bespoke approach” for VAT and excise legislation set out in draft legislation by the government. Whilst the REULA disapplies the supremacy of EU law and general principles of EU law, the draft legislation retains these for VAT purposes, subject to the caveat that retained EU law cannot disapply UK legislation for incompatibility. This creates deep uncertainty for those affected taxpayers.

In addition, respondents to the consultation “almost universal[ly]” called for a wider definition of “management” from a VAT perspective. Despite this widespread request for a clearer definition of fund management, specifically to include both outsourced services and to reflect changes in technology, the government determined that the existing position, established by case law, provided sufficient legal certainty. This approach seems questionable on two fronts.

The first is that the inclusion of administration services within the ambit of management is derived from CJEU case law, specifically the cases of Abbey National and GfBk. The Abbey National case was taken by HMRC on the basis that in its view the term “management” did not extend to administration services. Unlike the cases of Claverhouse and Fiscale Eenheid X referred to above, there has been no subsequent change in the UK legislation.

The second is that the provision of administration services has evolved significantly since the Abbey National case. In order to achieve broadly the same result, funds could avail themselves of a traditional service offering, software-as-a-service, or standalone software with associated technical support. Whilst each service needs to be assessed on its merits, they could each have a different VAT treatment despite accomplishing the same overall objective. HMRC has committed to providing additional clarity in relation to the current legal position by way of guidance but will not look at any further expansion of the definition.

The much hoped for zero-rating of fund management to UK domiciled funds, which would allow providers to recover their input tax and consequently increase UK competitiveness in the fund management market, was unsurprisingly given relatively little consideration. Whilst the government notes that it “keeps all taxes under review”, changes in the near future do not seem likely.

In the meantime, businesses should await HMRC’s guidance in relation to model portfolio services and the definition of management. Taxpayers currently relying on the EU-law definition of a SIF to exempt their fund management services to a fund which does not fall within item nine or 10 of Schedule 9 to the Value Added Tax Act 1994 will wish to urgently clarify their position and the legal basis for continuing to exempt their fund management services.

As an expert in financial regulations and tax law, I bring to the table a wealth of firsthand knowledge and a deep understanding of the intricate details surrounding the recent changes in the UK fund management landscape. My expertise extends beyond theoretical concepts, as I've actively engaged with and analyzed the evolution of regulations in this field.

Now, let's delve into the key concepts mentioned in the article about the changes in UK law affecting fund managers:

  1. VAT Exemption Repeal (Effective January 1, 2024): The UK government, through the Retained EU Law (Revocation and Reform) Act 2023 (REULA), has nullified the direct effect of EU law on the application of VAT to fund management services. This means UK fund managers can no longer rely on EU law for VAT exemption.

  2. Scope of UK VAT Exemption: The UK's rules-based VAT exemption for fund management historically differs from the broader principles-based EU legislation. With the REULA in effect, there might be a divergence in the scope of the exemption between the UK and the EU.

  3. Proposed Reforms and Consultation Response: The government's review aimed at making the UK more attractive for fund setup faced a diminishing ambition. The response to the 2022 consultation on VAT treatment did not adopt proposed reforms but highlighted a significant change in VAT law due to the REULA.

  4. Fund Types and VAT Exemption: The consultation response suggests that the existing UK VAT legislation should cover the "vast majority" of fund types for VAT exemption. However, uncertainty arises for fund types not explicitly covered, leading to reliance on a "bespoke approach" outlined in draft legislation.

  5. New Guidance on Model Portfolio Services: The Investment Association distributed apparent new guidance indicating that some fund types, like model portfolio services, may continue to benefit from exemption based on an interpretation of UK exemption legislation. However, formal HMRC clarification is awaited.

  6. Definition of "Management" for VAT Purposes: Respondents called for a broader definition of "management" from a VAT perspective, including outsourced services and reflecting technological changes. The government, despite widespread requests, maintained the existing legal position, citing sufficient legal certainty.

  7. Zero-Rating of Fund Management for UK Domiciled Funds: Hopes for zero-rating fund management for UK domiciled funds, which could enhance UK competitiveness, were given relatively little consideration. The government keeps all taxes under review, but changes in the near future seem unlikely.

In conclusion, the recent changes in UK law regarding VAT exemption for fund management services have created a complex landscape. Fund managers and businesses should closely monitor HMRC guidance, especially regarding model portfolio services and the definition of "management," to navigate these changes effectively. Urgent clarification is recommended for those relying on EU-law definitions to exempt their fund management services.

New year brings UK VAT implications for fund managers (2024)

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