In this thought leadership article, United Kingdom-based firm Buzzacott, provides insight into upcoming developments in VAT that could affect all VAT registered firms.
The impact of Brexit on goods being transported to and from the UK has been widely reported over recent months. Border delays, unexpected customs charges and general confusion surrounding the new rules have resulted in a challenging transition for companies shipping between the UK and the EU.
In this article, we focus specifically on the supply of financial services firms following the end of the Brexit transitional period. As well as giving you insight into upcoming developments in the VAT world that could potentially affect VAT registered firms.
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What is Brexit's key VAT impact on financial services?
Under the VAT rules prior to the transition period, a business providing Specified Supplies, such as financial services, to clients outside the EU was entitled to recover VAT on the costs associated with those services.
Specified Supplies are services which, for all intents and purposes, are VAT exempt, but they attract beneficial input VAT treatment pursuant to the Value Added Tax (Input Tax) (Specified Supplies) Order 1999 (the Specified Services Order).
A major consequence of Brexit is that the definition of Specified Supplies has been extended to include transactions with counterparties outside of the UK (and not just outside the EU, as was the case per the 31 December 2020). Because of this amendment, the scope of VAT recovery has been expanded. UK businesses making Specified Supplies to recipients established both within the EU27 and in the Rest of the World are now able to treat the VAT incurred in making those supplies as recoverable in full.
What should you be doing now following the changes to the Specified Supplies rules?
We recommend that UK based businesses review their VAT accounting processes and, in particular, adjust their VAT recovery methods. This is so that VAT on costs associated in making Specified Supplies to EU counterparties are identified and recovered in full.
Partially exempt businesses with EU based counterparties that apply the ‘standard method’ will also benefit from this change; however, in order to ensure that the changes outlined above are correctly reflected in VAT returns, we anticipate increased scrutiny from HM Revenue & Customs (HMRC) by way of more routine enquiries.
This change may also mean VAT registration becomes more attractive, as a larger proportion of income will allow VAT deduction. Previously, non-EU transactions alone may not have outweighed the administrative cost of operating a partial exemption method and filing VAT returns.
How will the rules affect supplies that straddle 1 January 2021 and what will the effect be on annual adjustments?
Input tax incurred after the end of the transitional period on 31 December 2020 that is used to make supplies of Specified Services to clients in the EU after 31 December will be recoverable. Input tax incurred before 31 December 2020 that was originally attributed to exempt supplies, but is used to make a specified supply after 31 December can be reattributed and treated as deductible as part of the annual adjustment.
Residual VAT incurred before 31 December 2020 will still be recoverable by reference to all the income received in the tax year in which it was incurred, even where the tax year includes Specified Supplies made on or after 1 January 2021.
Is there an impact for fund managers?
The supply of investment management services is generally VATable. But fund management services for funds located in the EU are treated as VAT exempt when those funds are recognised as Special Investment Funds (SIFS). There's no change to this post Brexit.
Where a fund does not qualify to be treated as a SIF, the supply is taxable, but if supplied to EU funds, it's subject to the VAT reverse charge, with the VAT due on the supply accounted for by the recipient in the EU country where the fund is domiciled.
The UK fund manager has historically had the right to recover VAT on the related costs. Going forward, these services are outside the scope of VAT, but are still subject to the reverse charge in the EU country in which the fund is domiciled and the UK-based fund manager continues to have the right to input tax recovery.
What other potential changes are in the pipeline for VAT and financial services?
Aside from the Brexit driven changes discussed above, there are a number of other developments as follows:
EU Review of VAT treatment of finance and insurance
The European Commission is currently conducting a far-reaching review of the VAT treatment of financial and insurance services. A public consultation was launched in October 2020 and has now closed. Options available include the removal of exemption from some or all finance and insurance transactions, to modify its scope through taxing only some types of services, e.g. fee-based as opposed to interest-based, to a more modest modernisation of the existing rules to remove market distortions and improve legal certainty. The Commission envisage putting forward a proposal for a new Directive by the end of 2021.
VAT treatment of fund management fees
In the 2020 Spring Statement, the Chancellor announced a review of the VAT treatment of fund management fees, and other aspects of the UK’s funds regime. The stated intention is to make the UK a more attractive location for the establishment of funds and asset holding vehicles. At the same time, a working group was set up to look at the VAT treatment of financial services generally. The review of fund management fees is not expected to commence until later in 2021.
Treasury call for evidence on VAT Grouping and Establishment
In August 2020, the Treasury issued a Call for Evidence on UK VAT group registration and the ‘establishment’ rules. It examines potential changes to the operation of VAT grouping in distinct areas, including application to branches, eligibility criteria, implementation of the Skandia judgment, compulsory VAT grouping and VAT grouping limited partnerships and Scottish partnerships. The changes as a result of the Call for Evidence could have one of the biggest VAT impacts on the UK financial sector where VAT grouping is common, in terms of ability to structure to minimise irrecoverable VAT.
Changes for private equity funds
This consultation is very relevant to private equity fund structures, which currently rely on an HMRC concession which allows limited partnerships to be VAT grouped in cases where the sole general partner of the limited partnership is a body corporate (and has a legal personality), and its role is to manage the limited partnership as a whole. This allows management fees to be outside the scope of VAT within the VAT group, reducing irrecoverable VAT. A similar concession allows corporate sole general partners of Scottish limited partnerships to join a VAT group. Given the importance of that concession to many private fund structures, any changes are likely to be significant to the industry.
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