As part of the Edinburgh Reforms announced by the UK Government (link back to “UK FS Reforms”), the UK Government has launched a public consultation on the VAT treatment of fund management. The consultation, published on 9 December 2022, is part of an ongoing review of the UK’s funds regime covering tax and relevant areas of regulation. The consultation proposes an amendment to UK legislation governing the VAT exemption of certain fund management services to improve policy certainty and remove the reliance on retained European Union law that has survived despite the departure of the UK from the European Union.
The reason for the consultation is that, for many years, the VAT treatment of fund management in the UK has mainly been derived from the EU VAT Directive (2006/112/EC, in this article referred to as the “Directive”). The Directive provides expressly, in Article 135(1)(g), for a VAT exemption of the management of funds known as Special Investment Funds, or “SIFs”. EU Member States have, broadly, delineated the boundaries of a SIF within the requirements of EU law (as interpreted by the Court of Justice of the European Union). Any management of funds that do not qualify as SIFs is subject to VAT at the standard rate, and is not an exempted supply for VAT purposes. Before Brexit, this legislation had direct effect in the UK, and was therefore retained in UK law as part of the UK’s Brexit settlement for retained European Union law.
The current UK VAT fund management regime is provided for by UK statute legislation, retained EU law and caselaw. Items 9 and 10 of Group 5 of Schedule 9 of the UK Value Added Tax Act 1994 (“Items 9 and 10 of Group 5”) contain a list of specific types of funds, the management of which is exempted from VAT. This list was originally intended to ensure equivalence of VAT treatment of fund management between the UK and the EU by specifying which funds qualify as a SIF in the UK.
The list in the UK legislation has been amended from time to time, mainly to keep track of case law that has determined that a wider range of funds (such as, for example, certain investment trusts) should also be treated as SIFs, and in response to policy developments regarding which funds should be granted a VAT exemption for the provision of their management supplies. That legislative evolution has also attempted to track the increasing sophistication of the fund management industry and proliferation of fund types.
The absence of a clear definition of a SIF (as opposed to the lists in Items 9 and 10 of Group 5) in existing UK legislation has not assisted legislative certainty or practical consistency. The approach of maintaining an evolutionary Items 9 and 10 of Group 5 list is therefore to be replaced with a new statutory definition of a SIF. The new definition also provides an opportunity for the UK government to remove from UK tax legislation the residual European Union law on SIFs.
The Proposed Reforms
The proposed reforms are not intended to result in a significant policy change in VAT treatment for the fund management industry. The aim is consolidation of the current VAT treatment of fund management in order to prevent fund managers in the UK from needing to rely on a patchwork of the existing UK exemptions in Items 9 and 10 of Group 5 and the SIF criteria derived from European Union law. The consultation proposes:
(i) retaining the list of exempt fund types currently comprising Items 9 and 10 of Group 5. The Government does not intend to expand that list in the future, so the retention is primarily focused on supporting the UK fund management industry, which currently utilizes these provisions and would not otherwise meet the new legislative SIF definition, and to ensure continuity through an effective codification of Items 9 and 10 of Group 5.
(ii) making legislative changes to bring relevant case law and guidance into UK law. This is an attempt by the Government to establish a defined criteria to determine which funds are entitled to the SIF exemption, alongside the existing list of funds in Items 9 and 10 of Group 5.
If this approach was adopted, the Government proposes the following requirements for a fund to be considered a SIF:
(a) the fund must be a collective investment;
(b) the fund must operate on the principle of risk-spreading;
(c) the return on the investment must depend on the performance of the investments, with the holders bearing the risk connected with the fund; and
(d) 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), being a fund intended for retail investors.
The proposed legislation does not include a requirement for the fund to be subject to “State supervision,” as is required in the European Union’s legislative guidelines, in order to enhance clarity post-Brexit. This is a departure from EU law and the judgment of the Court of Justice of the European Union in the case of Fiscale Eeinheid X NV (Case C-595/13). The government proposes that the legislation should contain a clear definition of “collective investment,” with the intention being for the definition to mirror the familiar provisions within the Financial Services and Markets Act 2000. This might need some degree of guidance and regulatory oversight, given how collective undertakings might be marketed to UK retail investors.
The consultation document seeks views on a proposed amendment to UK legislation, and is open until 3 February 2023. The Government has stated it will publish a formal response, and associated next steps, which will presumably include draft legislation, once consultation responses have been collated.
While the consultation’s aims are clear, they are also narrow. The Government states that “other options for policy reform in relation to fund management services do not fall within the scope of this consultation.” This leaves open the question of how the VAT treatment of management fees to non-retail funds, such as the Government’s onshore professional investor fund, might be managed.
Additional questions regarding the VAT treatment of services of management to non-collective investment vehicles, such as securitisation companies, to place UK-resident vehicles on the same footing as European competitors, is also not mentioned in the consultation.
The consultation also does not address issues regarding VAT input tax recoverability for UK-based fund managers where a non-UK fund vehicle is receiving supplies and is not intended for retail investors. It is hoped that this will be clarified in the Government’s responses to the consultation to prevent disadvantages to domestically-based UK investment managers.