Over the past 12 months, DFMs throughout the UK have been removing VAT from their model portfolio services (MPS). This is an industry-wide trend and, according to NextWealth research from December 2020, 14 firms out of a sample of 30 had removed this tax.
In addition, at that time a further six firms were actively reviewing the issue and, since those figures were gathered, a further three firms have ditched VAT on their MPS. This highlights a significant contrast from 2019, when NextWealth found all discretionary fund managers (DFMs) charged VAT (except for one that included this tax in its MPS fee). However, removing VAT is not always a simple task.
“There are operational issues that come into play and it’s not easy for platforms to remove the VAT,” says NextWealth managing director Heather Hopkins.
“In our research we heard that one platform in particular has to manually replicate the DFM’s model portfolios and move people out of the existing MPS into the new one so as not to trigger a capital gains tax implication. This requires a lot of resource from the platform.”
Heather Catlin, indirect tax partner at KPMG UK, says difficulties arise from the complex nature of VAT and defining where it does – and does not – apply.
“There are a number of things to consider holistically, including: the level of contact and intermediary activity between the parties, the extent and context of stock changes within the portfolio, the involvement of an IFA and even the invoicing and charging arrangements,” Catlin says.
“This, coupled with the market-based context of the MPS shift and the challenges in getting HMRC rulings, has made it difficult for many providers to confirm the availability of VAT exemption.”
As a result, Hopkins expects this could be a disadvantage for smaller DFMs that lack the heft to command such change with their platforms.
“Platforms are very cooperative, but it’s a question as to whether smaller DFMs will be able to command this sort of change,” Hopkins notes.
“There is huge pricing pressure on the MPS fee, especially with the vertically integrated providers charging 0% or near 0% fees for their MPS. Which means DFMs are increasingly trying to differentiate through service and proposition. Pure play DFMs will typically differentiate on their process and how they go about investing.”
‘VAT reduction could be short-lived’
The lack of any overarching guidance on the issue complicates matters. The government had intended to address this in a review originally announced in Chancellor Rishi Sunak’s March 2020 Budget, but the pandemic has delayed this.
Deloitte tax director David O’Kane even warns there could be a chance of the government ruling against the direction the industry has taken by concluding that VAT is payable.
“In this event, DFMs will likely be required to make a VAT payment to HMRC to cover periods during which they treated MPS management as VAT exempt,” O’Kane warns.
“This payment would also be subject to interest and potentially penalties, although the penalty risk may be mitigated if the DFM has sought guidance from HMRC, demonstrating that reasonable care has been taken. From an investor perspective, it could mean that any reduction in fees could be short-lived if DFMs are required to recommence charging VAT.”
This lack of clarity means firms are seeking one-on-one clarification to avoid falling behind.
“We have taken some professional tax advice and have been communicating with HMRC and will be taking VAT off our MPS from 1 February following a recent confirmation that we can do this,” says Wellian Investment Solutions investment director Chris Mayo. “It’s likely that all DFMs will be doing this at some point, if they aren’t doing so already.”
Square Mile Research is another firm actively reviewing this, but a company spokesperson pointed out this is still a complex issue, saying: “Even with VAT our services are extremely competitive relative to many off-the-shelf products offered by our peers. We are reviewing our position, but this is a complex issue and so we are consulting with HMRC to ensure that any steps we take comply with both the spirit and letter of their guidelines.”
As such, O’Kane insists HMRC must provide clearer guidance on this issue as the removal of VAT gives considerable pricing advantage to some DFMs.
“Treating MPS management as VAT exempt and reducing fees by 20% could have a considerable impact, if an investor selects a DFM based on price alone,” he says.
“Many DFMs are now self-assessing that their MPS management is VAT exempt but, as HMRC are yet to provide the industry with definitive guidance in this regard, they are not doing so without also taking on a level of risk.”