Edinburgh Reforms: VAT treatment of fund management services

However, although VAT on management fees is an area ripe for fundamental reform, the proposals only aim to clarify the boundaries of the existing VAT exemption. In our view, that makes it a slightly missed opportunity to enhance UK competitiveness.

Background

The current UK VAT rules are problematic in two respects:

1. there is an exemption from VAT for management of certain funds, but its scope is unclear; and
2. fund managers generally receive a more favourable tax position for making supplies to foreign customers than domestic ones. This incentivises the use of non-UK structures.

With Brexit giving the UK freedom to depart from the EU position, the asset management industry has been pushing for reform to the VAT rules to address these issues and boost the UK's attractiveness.  The optimal position for the industry would be the zero-rating of asset management fees (as this means managers do not have to charge VAT on their fees but can recover their own input VAT).  This would remove the incentive to use non-UK structures, and make the UK highly competitive.

Today's consultation

Despite the government having said in February that zero-rating was not on the table, there had been rumours that it was still being considered.  However, today's consultation is more limited, aiming to clarify the boundaries of the existing fund management exemption (i.e. address point 1 above) rather than more radically change policy. 

The consultation document explains that the government intends to:

1. introduce a characteristics based test, with the VAT exemption applying to any fund with certain features; and
2. retain, but not update, the current statutory list of exempt funds.

The proposed characteristics are:

• the fund must be a "collective investment" (with the government proposing to use a definition broadly mirroring that used in the Financial Services and Markets Act);
  
  
• the fund must operate on the principle of risk-spreading;
  
  
• the return on the investment must depend on the performance of the investments, and the holders must bear the risk connected with the fund; and
  
  
• the fund must be subject to the same conditions of competition and appeal to the same circle of investors as a UCITS (Undertakings for Collective Investment in Transferable Securities), that is funds intended for retail investors.

Comment

The limited scope of the consultation is slightly disappointing, as the VAT treatment of fund management is an area where the UK has the opportunity to give itself a competitive edge over its European rivals.  However, it is unsurprising, given the current economic climate, that the government has not revisited its decision not to extend zero-rating to fund management.

Although the government is saying that the proposals are just clarifying existing law, given the uncertainty as to what the current law actually is, the selection of the relevant criteria for identifying funds to which the exemption will apply, arguably involves a significant element of policy choice.  In this regard, it is noteworthy that the government is looking to limit the exemption to funds intended for retail investors, a position not taken by all other EU jurisdictions (e.g. the Luxembourg exemption is not as limited).  Indeed, it will be interesting to see where we land on what counts as "retail", bearing in mind the current government and industry focus on increasing "retail" access to less liquid investments.

As we have been waiting for the consultation since March 2020, the timetable for responses is relatively tight, with comments required by 3^rd February next year. Travers Smith will be involved in the consultation and we'll keep you updated.

Read the consultation.