UK tax tribunal highlights HMRC’s narrow VAT exemption interpretation

In a recent decision, the UK’s First-tier Tax Tribunal (FTT) addressed the VAT exemption for fund management services provided by CCLA Investment Management Limited to thirteen investment funds. These funds primarily consist of investors who are charities, Church of England entities, and local authorities.

Bryn Reynolds, tax law expert at Pinsent Masons, said: “The decision highlights the UK’s implementation and HMRC’s interpretation of the investment management exemption for VAT was unduly narrow. Whilst previous cases had led to the UK iteratively widening the scope of the national legislation, the UK is unlikely to legislate to widen the scope of the exemption.”

The appeal centred around whether CCLA’s fund management services qualify for exemption from VAT defined by EU and UK law.

In relation to the fund management services CCLA supplies to charity authorised investment funds (CAIFs), it can rely on an exemption from VAT for its services. However, when it was supplying the same services to other funds that were also charitable but not established as CAIFs, CCLA had been applying the standard rate.

CCLA argued that the non-charitable services should be exempt on the basis that they were supplies of fund management services to ‘special investment funds’ (SIFs). The fund management firm applied to HMRC for a refund of the VAT it had paid, less input tax it had recovered, in relation to the two years between 1994 and 1996 and the 17-year period between 2003 and 2020. HMRC refused the claims.

CCLA’s claim relied on the direct effect of article 135(1)(g) of the VAT directive, being the SIF exemption, during the relevant periods, all of which were pre-Brexit and therefore subject to EU law such as the Alternative Investment Fund Managers Directive (AIFMD).

The question to be decided was whether each of three different types of fund met the definition of SIF for these purposes. The parties were broadly in agreement that the question that needed answering was whether these types of fund had characteristics that are equivalent to those of an undertaking for collective investment in transferable securities (UCITS) or sufficiently comparable to UCITS so as to be in competition with them.

To answer that question, the FTT had to decide whether the funds are subject to specific state supervision, and whether they are subject to the same conditions of competition and appeal to the same circle of investors who would use UCITS.

The FTT concluded that in order to meet the first of those conditions, the actual fund does not have to be directly regulated by the UK’s Financial Conduct Authority, but rather subject to supervision that is sufficiently comparable to the supervision of a UCITS. The FTT found that supervision under the AIFMD meets this requirement and therefore those funds, that were supervised under AIFMD when it came into force in 2014, were subject to state supervision from that date.

However, the funds still also had to meet the ‘circle of investors’ requirement.

There were three types of fund: charities official investment funds (COIFs), registered charities which other charities invest into; Church of England Central Board of Finance Funds (CBF), registered charities in their own right whose investors are entities within the Church of England; and Local Authorities’ Property Funds (LAPF), whose investors were local authorities, which are set up under a UK Treasury scheme and not a charity.

The FTT found that the COIFs met both requirements from 2014 onwards and therefore fund management services in relation to them were exempt from 2014, but not before. The tribunal found that the CBFs were never subject to state supervision and therefore services supplied to them were standard rated. Finally, the LAPF met the supervision requirement from 2014 but not the circle of investors requirement and therefore services supplied to it were standard rated

Reynolds said: “The decision will leave HMRC grateful that following the consultation on the VAT treatment of fund management, HM Treasury opted against introducing a principle-based definition of a SIF and instead retained a rules-based approach. As such this decision will have limited impact although retrospective claims may still be possible and alternative investment fund managers should be considering the nature of the AIFs they manage and whether a claim is viable.”