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Hedgeweek Update: UK Customs & Excise VAT position

Robert Mellor and Mike Arnold of PricewaterhouseCoopers in London provide additional comment to our earlier article on the issue of VAT.

UK Customs & Excise has revised its position in relation to the VAT treatment of management services provided to non-UK funds.

The move by Customs & Excise has been announced in a Business Brief (10/2003). It follows extensive lobbying on the issue by representative bodies such as AIMA and the IMA, and other professional advisers.

In the Business Brief, Customs & Excise states that notwithstanding the form of the legislation due to come into force on 1 August 2003, it will treat the management of investment funds established outside the UK, including Dublin funds, Luxembourg SICAVs and the Cayman and other open-ended companies typically used by hedge fund managers, as being outside the scope of VAT.

More importantly, UK managers of such funds will retain the right to recover input VAT on costs incurred by them in providing such management services.

Martin Shah of Simmons & Simmons, the City law firm, who has lobbied Customs & Excise on the subject and discussed the issue with Customs & Excise on 14 July, said: "The Business Brief by HM Customs & Excise will be warmly welcomed by UK hedge fund managers.  In the absence of this Brief, UK managers would effectively have faced a 17.5 per cent increase in their non-salary costs from 1 August 2003."

Non-UK Open-Ended Investment Companies

The Business Brief confirms that notwithstanding the change of law coming into effect on that date, Customs will treat supplies of management services to non-UK open-ended investment companies as outside the scope of UK VAT.

More importantly, UK managers making such supplies will have a right to recover VAT incurred by them in respect of those supplies, on items as disparate as rent, Reuters screens and advisers' fees.

Non-UK open-ended investment companies, typically in the Cayman Islands, form an integral part of many hedge fund structures.

Mr Shah told Hedgeweek: "Had Customs not sought to preserve the status quo for managers of non-UK open-ended companies, the UK would have become a less attractive base of operations for European hedge fund managers.  Customs should be congratulated for listening to the industry and acting swiftly to answer managers' fears."

Whilst Customs' position is in practice a concessionary treatment, it is hoped that the legislation will be changed to reflect this practice.

UK Funds and Management

In relation to UK OEICs, the Business Brief does not show any relaxation in Customs' position that "management" means management of the fund's assets, rather than administration and registration services.

Mr Shah noted: "This an area where the UK law is not entirely consistent with the European directive which it seeks to implement.  Given the growth of business process outsourcing in the financial services sector, our feeling is that further litigation in this area is a real possibility."

Robert Mellor, a Director with PwC's Investment Management team commented: "The more clearcut distinction that Customs and Excise have now introduced between the management of UK and non-UK OEIC's is potentially going to present a barrier to the introduction by the FSA of a UK domestic hedge fund collective investment vehicle."

Mr Mellor said:"Whilst the FSA seems to be keenly aware of the need for the direct tax issues surrounding such a domestic vehicle to be addressed they will now also have to consider the impact of the VAT mis-match between offshore and onshore hedge fund vehicles; how will a future UK hedge fund vehicle compete if it has a 17.5% cost base disadvantage to the existing offshore market?"

While the announcement by Customs and Excise is welcome news, hedge funds and their managers may still face problems ahead. 

First, Customs and Excise could revoke their "concession" at any time and under the rules of the governing EU VAT Directive there is no VAT recovery for managers of offshore special investment funds as defined by Member States.

Second, the VAT treatment of cross-border fund management services for investment funds is the subject of anticipated ruling by the European Court of Justice in the case of Banque Brussels Lambert.

Mike Arnold, a Partner in PwC's Investment Management team adds: "Some further change is perhaps inevitable due to both VAT case law and evolving cross-border business structures. Hedge funds will need to consider very carefully which VAT model they need for the future if the on-shore market is to develop and compete."

Expert assistance in preparing this article was provided by Martin Shah at Simmons & Simmons, and Robert Mellor and Mike Arnold at PwC in London.

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