A look at VAT on research after MIFID2
By Marie Barber, Managing Director, Tax Consulting and Ryan Kulczycki Vice President, Compliance and Regulatory Consulting, Duff & Phelps
Published: 21 January 2018
What is this article about?
MIFID II has arrived this January, carrying with it the policy aim of increasing transparency and reducing conflicts of interest around inducements. In implementing this policy MIFID II changes the way investment research is supplied. This has the knock on effect of changing the nature of VAT treatment of investment research. For some investment managers this may result in a higher level of VAT taxation. We explore some of the key questions about how VAT will work now.
What was the VAT position?
VAT is based around the concept of supplies of good or services. Where a combination of services that are inseparable are supplied together, the whole service takes on the characteristics of the primary service. Where the services are separately supplied, the VAT treatment must be separately considered for each.
Previously research supplied by brokers together with execution services was treated as one inseparable supply. The research took on the characteristics of the primary part of the supply that was VAT exempt execution services, which maderesearch provided as part of that inseparable supply also exempt.
What has changed?
From 3 January 2018 when MiFID II became live, research and execution can no longer be provided as one single supply of services and instead research must be priced separately to execution services.
Each supply has its own VAT treatment with execution generally being exempt from VAT (meaning the broker will not apply VAT to execution fees) and research being a standard rated VAT supply with VAT applied at 20 percent. The impact of receiving research on which VAT has been applied depends on the manager’s position with respect to recovering VAT.
How does VAT exemption and VAT recovery work?
Exemption is a tricky word in VAT, common sense would imply it means that no VAT is charged, but this is not the full story.
There are 4 main ways a transaction can occur with no VAT being applied:
- It is an exempt service - which is a limited set of specific services;
- It is outside the scope of VAT because there is no supply of goods or services;
- It is outside the scope of VAT because the place of supply is in another country; or
- It is zero rated, i.e. VAT is applied but at 0%
Situations 1 and 2 do not result in a taxable supply, whereas 3 and 4 usually do. This is important because a firm that makes taxable supplies to others through its sales, can recover VAT incurred on its purchases. If a firm makes exempt supplies there is no taxable supply to others, that means there is no recovery of VAT on purchases, therefore being VAT exempt is not always favourable as it stops recovery of VAT on purchases.
Am I making taxable supplies?
Investment management in general is a taxable, standard rated supply for VAT purposes, with the significant exception of investment management provided to Special Investment Funds (‘SIF’s).
What about Special Investment Funds?
This is where it gets tricky. One specific type of investment management is exempt for VAT purposes, that is a supply to a Special Investment Fund (“SIF”). As a result, the VAT paid by an investment manager on the services it has received to enable it to provide services to a SIF is not recoverable. Furthermore, this exemption reaches back down the chain of services to any services directly attributable to management of a SIF.
One important point to note here is that tax authorities take a wider view of what counts as “investment management “ than a body like the FCA. Two notable legal cases, (ECJ C-169/04 and C-275/11) have analysed the scope of management such that it is possible some research may conceptually count as management for tax purposes.
What is a SIF?
One would hope you could look at the definition in the legislation, unfortunately we again need to go to the case law. Legal cases (like ECJ C-363/05 and C-464/12), have widened the scope of the SIF definition from its original definition of a fund marketed to UK retail investors to include UCITS funds, certain types of pension funds and more.
Will I be charged VAT on research?
If the research purchased is directly attributable to the management of a SIF then the supply of research purchased is exempt and no VAT should be added by the research provider.
If the research purchased is not directly attributable to the management of a SIF then the supply of research will be taxable. If the research provider is based in the UK VAT will be added at 20%.
If the research provider is based overseas the standard VAT rules on place of supply of services apply. The research will have no VAT added to it by the provider, but you will need to apply the reverse charge mechanism. Reverse charge makes you account for the VAT that would have been added if the services were supplied in the UK, by accounting for a notional sale and purchase.
Will I be able to recover the VAT I am charged on research?
If you only make taxable supplies you will be able to recover any VAT you are charged on the research, the reverse charge on overseas research purchases will not have economic cost.
If you make exempt supplies you will not be able to recover any VAT you are charged on the research, the reverse charge on overseas research purchases will be a cash cost.
If you make a mix of exempt and taxable supplies the normal partial exemption rules will apply.
If you are not VAT registered then you will not be able reclaim VAT, but be aware that the notional sale that reverse charge purchases trigger, count towards the VAT registration threshold.
What about CSAs and RPAs?
Commission sharing agreements (‘CSA’s) were a common way of paying for research by diverting part of a brokers commission towards a research provider. CSAs that take a charge proportional to the volume of trades are no longer allowed under MIFID II. They have been replaced by Research Payment Accounts (‘RPA’s) one form of which allows collection of an amount alongside a commission that is not volume linked and has additional administrative requirements.
VAT applies to the supply of services, the supply is distinct from the payment of a service. In most cases the person who receives the supply also pays. Only the person who received the services can recover any VAT added therefore any situation where the person receiving the service is not paying for it, like an old CSA or a new RPA that is modelled as tripartite agreement needs careful VAT consideration.
Another form of RPA has a direct budgeted charge to clients from the manager, careful consideration of the contract under which that charge is made needs to be undertaken to determine if it qualifies as a supply of services with associated VAT liability.
What has HMRC changed?
Nothing in the VAT rules has changed. HMRC have made no amendments to the VAT regulations which derive from EU based legislation. The application of VAT derives from the general VAT rules applied to the change in treatment under MIFID II to not regard research and execution as inseparable
Notwithstanding that HMRC haven’t explicitly acted to raise the taxation burden it has risen none the less and the Office for Budget Responsibility claims this will raise GBP40 million a year for the Treasury.
This is largely out of HRMC’s control as, BREXIT notwithstanding, the concepts applied follow from the EU VAT directive.
What’s the problem?
An investment manager that does both of these:
- makes partially or fully exempt sales; and
- purchases research not directly attributable to management of a SIF with VAT added to it (notional or actual);
will have irrecoverable VAT on that research which effectively makes that research purchase up to 20% more expensive.
What action do you need to take as a manager?
As an investment manager you should assess:
- if you are managing a SIF are you being charged the right VAT on directly attributable purchases;
- who research is supplied to (as opposed to who is paying), as only the recipient of supply has a right to reclaim the VAT on the purchase;
- in your RPA agreements, if you are using them, make sure you can identify where the supply of services exist and the VAT liability of that supply;
- if you are applying the reverse charge mechanism correctly; and
- if you are reclaiming VAT appropriately?
MiFID II came into force on 3 January 2018 and we expect that you have already had conversations with your suppliers about the research they are providing, who it is being provided to and how it will be charged. You should make sure that your accountants and those preparing your VAT returns are fully aware of these conversations.
Contact the authors:
Marie Barber, Managing Director, Tax Consulting at Duff & Phelphs: firstname.lastname@example.org
Ryan Kulczycki, Vice President, Compliance and Regulatory Consulting at Duff & Phelps: Ryan.Kulczycki@DuffandPhelps.com