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VAT AND RDR - THE FINAL GUIDANCE

Paul Kennedy, director of tax & trust planning at Fidelity FundsNetwork, offers some background summary information on HMRC’s recently issued VAT guidance on the Retail Distribution Review



HM Revenue & Customs (HMRC) recently issued VAT guidance on the Retail Distribution Review (RDR) and adviser fees, which can be found within the VAT Finance Manual and the VAT Insurance Manual. The new guidance relates solely to advice services concerning retail investment products as defined under the RDR and this article will be similarly confined.

The new RDR rules require advisers to move from receiving commissions to fees agreed with clients in respect of all retail investment products as defined by the FSA. These are, whether or not held within an Isa or a child trust fund, a life policy; a unit (right or interest of the participant in a collective investment scheme); a stakeholder or a personal pension scheme; a security in an investment trust or an interest in an investment trust savings scheme; any other designated investment that offers exposure to underlying financial assets, in packaged form which modifies that exposure compared with a direct holding in the financial asset; or a structured capital-at-risk product.

Retail investment products do not include protection-only insurance or charges for trading in securities. The new RDR rules apply to all product distributors and providers across the retail investment market involved in advised sales. They also apply to advised sales via platforms. These rules do not apply to investment management under a discretionary mandate or to execution-only transactions, which are covered in other sections of VAT guidance.

The UK is required to implement its VAT law in accordance with European Union (EU) law. The UK cannot implement its own VAT laws especially for advisers nor can it interpret VAT for advisers in a way that is inconsistent with EU law. There is no change to VAT law but what HMRC has done is to provide very helpful guidance on how existing VAT law will be applied.

A starting point

It is important to remember there is no universal exemption from VAT for the services of an adviser – that certain adviser fees may be exempt from VAT arises because of ‘involvement’ with exempt insurance and financial products. EU law dictates member states must not charge VAT on certain defined insurance and financial products, but it goes further than that. It also states the arrangement or negotiation – often called ‘intermediation’ – of those defined insurance and financial products should be exempt from VAT.

Services of an adviser – 
Stages 1 to 6

Within the guidance, HMRC has outlined a typical role of an adviser in the retail investment market. This will involve the adviser entering into arrangements with the client, under which they might:
1. Gather information about the client (factfind).
2. Carry out research to find suitable investment options.
3. Provide the client with reports, financial health-checks and forecasts.
4. Recommend specific investment products to the client, including the prices at which these can be arranged.
5. Act between the product provider(s) and the client with a view to arranging the sale of the retail investment products agreed with the client.
6. Where applicable – that is, where the client agrees to an ongoing review service – monitor the client’s ongoing position to ensure the products continue to meet the requirements of the client.

The guidance states that “where the customer [client] is seeking the arrangement of a retail investment product and the adviser performs the arrangements as outlined at stage 5 above, (regardless of whether the sale of the product is finally concluded) and is able to evidence they have done so, the services in stages 1 to 6, which fall within the agreement concluded with the customer [client], will be VAT-exempt.”

The VAT liability depends on what is done by the adviser and it makes no difference whether a fee is levied upfront or over the life of a product. Where one or more of the stages are contracted under a separate agreement, so the service provided to the customer is that of general advice or recommendation only, any charges to the client will carry VAT at the standard rate. Additionally, where there is no evidence of such product arrangement services, any charges to the client will carry VAT at the standard rate.

It therefore follows adviser fees can only be exempt from VAT where there is some activity relating to the potential arranging or negotiation of exempt insurance and financial products. Do remember it is your and your client’s ‘involvement’ with exempt insurance and financial products that creates the exemption from VAT. If there is no potential for arranging an exempt insurance or investment product, there can be no VAT exemption for your fee. Similarly, if the product or service potentially being arranged is not itself VAT-exempt, your fee will not be exempt.

VAT and ‘advice’

Much confusion has been caused by the use of the term ‘advice’. Advice can have several meanings – there is the regulatory definition, there is a tax definition and there is an everyday meaning. Each is different, they are not synonymous and an adviser will provide advice in many different guises.

While some of the old adages were well-intended, they ultimately served to confuse more than assist. For the purposes of understanding the new guidance, I strongly recommend you put aside the word ‘advice’ and concentrate more on the word ‘services’. You provide a ‘service’, whatever it may be, for which you charge a fee. The HMRC guidance outlines when your services are exempt from VAT.

Ongoing services:

The guidance provides that if, after the arrangement of the sale of retail investment products, the client signs up to ongoing review services, some or all of the process (as detailed in stages 1 to 6) may occur again. The adviser should be able to determine and evidence where they are in the process with that client. The VAT liability of ongoing services will depend upon the services the customer has agreed the adviser should perform.

Evidence

The guidance makes clear advisers must keep sufficient evidence to support the VAT treatment applied to the services supplied. This evidence will need to be specific to the services performed for the client and demonstrate the adviser acted between the client and product provider with a view to arranging the sale of retail investment products. If an adviser is unable to provide evidence an exempt supply has taken place, VAT will be due on that supply.

It is imperative the nature of the service being provided is properly evidenced at the time the services are agreed. Client contracts, agreements or letters of engagement should properly outline the nature of the service agreed to be provided and client files should evidence the services actually performed.

The ‘wheel’ of VAT-exempt services

In summary, where a client seeks services with a view to the arrangement of a  transaction [sale] of an exempt insurance or investment product and your services are provided to that end – even if a transaction does not actually take place – the service will be treated as VAT-exempt.
One might look at the six-step process as a ‘wheel of services’. Provided your initial or ongoing service is on that wheel and has an end-game in mind of step 5, that is, to act in an intermediary role in arranging transactions in an exempt insurance or investment product – regardless of whether a transaction does actually take place – your services are VAT-exempt.
If your services do not have an intended endgame in mind to act in an intermediary role in arranging transactions in an exempt insurance or investment product, they cannot be exempt. That is the nature of the VAT exemption and there is no VAT exemption for services we might term ‘general’ or ‘holistic’ advice. Neither is there exemption for services that fall short of ultimately having a view to arranging transactions in exempt insurance or investment products. This is the basis of EU VAT law and the guidance is very fair in its interpretation.
In reality, the requirement the service requires an intermediary role in arranging transactions in an exempt insurance or investment product will often be the very nature of the service an adviser intends to provide and the service the client seeks. If you examine the service you currently provide to many of your retail investment clients, it is likely steps 1 to 6 will be in place as part of that service.
Finally, ‘the wheel of services’ outlines advice functions in relation to exempt insurance and investment products. It is important not to forget the requirement your services must relate to retail investment products, as defined above.

Ancillary services

As part of the services outlined in stages 1 to 6, adviser services may often include ancillary services that, if they stood in isolation, would not be VAT-exempt. For example, the VAT exemption for intermediary services does not in itself cover: accountancy, taxation or legal advice; services of general financial or investment advice; valuation of assets; or investment analysis or market sector research.

If you are providing any of the above, or any other non-exempt services as part of the services outlined in stages 1 to 6, you must consider whether there is a single exempt supply or supply of multiple services. Even though there may be additional components beyond stages 1 to 6, it will still be a single exempt supply if there is clearly the one overall supply being made and to which the remaining components can be seen as integral, incidental or ancillary.

Integral elements include anything essential or necessary as part of the supply of the core stage 1 to 6 services. Incidental elements are ones that naturally accompany the core stage 1 to 6 services but are not generally a significant part of them.

As this can be a complex area of VAT law and the decided cases are not wholly conclusive, you should always discuss your firm’s individual circumstances with a relevant professional adviser. Generally, if your fee relates wholly or primarily to services that are outside exempt intermediation, VAT will apply.

For example, an annual service comprised primarily of the provision of valuations, tax information and newsletters with general market commentary would be chargeable. Where these types of thing are integral, incidental or ancillary to a principal service of intermediation of exempt insurance/financial products – steps 1 to 6 above – then the more likely it is there is only one single exempt supply.
 

Discretionary investment management

The precise nature of how discretionary investment manager and IFA agreements operate regarding commissions and/or fees will differ. However, at a fundamental level discretionary investment management services provided to a private investor are subject to VAT in the UK.
Accordingly, any IFA fees or commissions associated with advice leading to the introduction to a discretionary investment manager, or ongoing fees or commissions associated with advice concerning a discretionary investment manager service, are fees/commissions related to a taxable product and not therefore fees/commissions associated with the negotiation of an exempt product. Current HMRC guidance for advisers states:

* Regardless of how an adviser is remunerated, there is no VAT exemption for the introduction of a client to a discretionary investment management service because discretionary investment management is a taxable service that does not fall within the financial services exemptions. The service provided by the IFA is a taxable introduction to a taxable management service. It is not correct for IFAs to look through to the selection and purchase of VAT exempt assets by the discretionary investment manager and treat their services as being exempt introductions to a series of VAT exempt transactions.
* Investment managers may assume they have not charged VAT on taxable fees and commissions by IFAs because the IFA is not VAT-registered. It may however be the case some IFAs are incorrectly treating commission as exempt income when it is taxable and should therefore be registered and charging VAT. To assist with this monitoring process it is advisable both parties regularly review and update any Self Billing Agreements that are in place between them. IFAs should inform managers immediately of any changes in their VAT status.
Within the wider EU, emanating from the German Courts, there have been recent questions concerning the VAT treatment of discretionary investment management services, which are currently the subject of referral to the European Court of Justice (ECJ). The court has been asked to rule on whether discretionary portfolio management services provided to individual investors are exempt from VAT under the exemption for negotiation in investments.
In that case Deutsche Bank provided discretionary services in accordance with a generic strategy chosen by the investor. The annual fee was 1.8% of the value of the assets managed, comprising 1.2% for management and 0.6% for buying and selling costs. The fee also covered account/portfolio administration and commission on the acquisition of investment fund units. Investors received regular progress reports and could terminate the instruction at any time with immediate effect.
The opinion of Advocate General Sharpston, delivered on 8 May 2012, was that portfolio management services of the kind at issue formed a single supply for VAT purposes and such services do not fall within the exemption provided for in the EU VAT Directive.
Accordingly, there is nothing immediately within this opinion to suggest discretionary fund management fees should be exempt from VAT or that any fees charged by IFAs in connection with discretionary fund management services should be similarly exempt. However, it still remains to be seen whether the ECJ will follow the opinion of the Advocate General in its final ruling. Once the case is finally concluded, it is possible further HMRC guidance will emerge.
 

Non-exempt fees and VAT registration

Advisers may undertake work for fees that are not exempt from VAT. Where registered for VAT, tax should be charged at the relevant rate. If not registered, then VAT will not be charged. Any business that makes taxable supplies that exceed the current registration threshold must register for VAT. It is therefore important advisers monitor their taxable turnover and are careful to include all taxable fees and commissions (including those for introductions to discretionary fund managers). The current VAT registration threshold is £77,000 but is subject to change and it is important businesses check it regularly.
 

Other VAT guidance

As mentioned at the outset, other VAT exemptions exist for intermediaries and further details can be found within legislation, HMRC VAT Finance Manual, VAT Notice 701/49 Finance and other HMRC materials. Further detail on VAT and advice may be found at www.hmrc.gov.uk.

Please note: This is a summary article only and is not intended to act as a guide upon which advisers should base the VAT treatment of their fees and/or commissions. Appropriate advice should always be sought from a relevant professional adviser. No party should act or refrain from acting on anything contained in this material. Relevant primary materials should always be consulted at all times for all purposes. No statements or representations made in this material, document or at the presentation are legally binding on Fidelity or the recipient and no liability is accepted in connection with this material. FundsNetwork cannot give advice regarding tax. This paper contains Public Sector information licensed under the Open Government Licence v1.0.

 

 

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