Adviser Charging and VAT and other tax issues for the post-RDR world

PFS London - Crossing the RDR Rubicon

The Eastland 1912

Unintended Consequence on July 24th 1915

New Regulation - Lafollette's Seaman's Act was signed into law on March 4, 1915

Passenger Deaths - 818

Passenger Deaths - 844

Unintended Tax Consequencesof Adviser Charging (AC)

• VAT• Only two ways of getting money from a

product to facilitate AC• Hijack the Premiums• Surrender/Withdraw/Redeem – with tax consequences of

Action

• Facilitating charges from within tax wrappers – client best interests

So what Changes?

• Pre – RDR– Tax Legislation

• VAT Act 1994

– Commission • Was regarded as the proxy

indicator for Intermediation

– Fees for Advice• Often times VAT added

mistakenly

– HMRC Guidance• Relies on “predominant

service” concept

• Post – RDR– Tax Legislation

• Still VAT Act 1994

– Commission• Gone apart from Legacy• We lose our proxy indicator

for Intermediation

– Fees for Advice– HMRC Guidance

• “predominant service” concept gone

• Intention, perhaps, more important

– But beware!

Important Principles

• The guidance must clearly reflect the legislation and legal precedents applying.

• An adviser acts as agent to the client and has a duty to act in the best interest of the client under normal agency law. This is further reinforced by FSA rules. Since this is the case, the adviser must ensure that a client is afforded the correct VAT treatment of his adviser charge. He should not charge VAT just because it may be easier and makes the business administratively simple. HMRC has no interest in collecting a tax that is not legally payable.

• The guidance to the industry must be practical and must be subject to a clear test that can be utilised by both adviser and HMRC in the determination of VAT treatment.

• The word advice is utilised by other professions and there is a clear rationale for the VAT treatment of advice being different for financial advisers than for say accountants, tax professionals and solicitors.

• The VAT treatment of a supply must be capable of being determined up front before the work is engaged on.

Exempt Financial Services

• In general, financial services are exempt from VAT

• Most important exemption is for intermediation

• A financial adviser will be supplying an exempt intermediary service if (s)he– brings together a person seeking an exempt financial

service with a provider of an exempt financial service

– stands between the parties and acts in an intermediary capacity, and

– undertakes work of a specialised nature, preparatory to the completion of a contract for the provision of financial services, whether or not it is completed.

Regulated activities and the permissions regime

The Regulated Activities Order (RAO) sets out which activities, in relation to which products are to be regulated. The FSA packages the activities up into a permission regime and uses the regime in their Part IV authorisation for firms. The Permissions for the purposes of this guidance can be divided into those that are fundamentally intertwined with intermediation - i.e. the final link in the chain of bringing those who wish to acquire financial products and those who wish to provide them, and those which involve some other activity which does not involve arranging, dealing or otherwise executing acquisition of financial products.It is the involvement in regulated activity which sets apart the Regulated Financial Adviser from any of the other professions and the VAT treatment should be fundamentally driven from these permissions.In order to operate as a Financial Adviser a number of regulatory permissions are required, particularly:

• Advising on Investments• Arranging Investments

In order to be involved in regulated advice it must involve a personal recommendation. By the very nature of being involved in regulated advice you are completing the intermediation chain. It is the way that the firm’s permissions are being used that should form the genesis of the VAT treatment.

What Services does a Financial Adviser offer?:

Even though he/she may develop a financial plan, the object of the financial plan will be to recommend which product types and which product providers customers are going to use to fulfil their plan.If the supply depends on the use of advising on investments and arranging investments then it is clear that this is part of intermediation and it is therefore exempt.

Six stages of the adviser’s role

1. Gather information about the customer;

2. Carry out research to find suitable investment options;

3. Provide the customer with reports, financial health-checks, forecasts;

4. Recommend specific investment products to the customer, including the prices at which these can be arranged;

5. Act between the product provider(s) and the customer with a view to arranging the sale of the Retail Investment Products agreed with the customer;

6. And, where applicable, i.e. where the customer agrees to an ongoing review service, monitor the customer’s ongoing position to ensure that the products continue to meet the requirements of the customer.

If a financial adviser is providing a service that involves advising on and arranging retail investment products, then the services are part of intermediation and are exempt from VAT. In this context, advice covers a broad range of functions including primarily personal recommendation, referral and intermediary work around product distribution.

What’s in a name?

Financial Planner?Wealth Manager?Portfolio Services?

IFA?Adviser?

Investment Manager?

HMRC Menu of Services

VAT Supply Description VAT liability

Execution only Buying or selling securities on a client’s instructions, but

without offering advice on the transaction.

Exempt

Advice General financial or investment advice that is not

provided as part of a complete service that includes an

exempt financial service.

Taxable

Intermediation

or

‘Advised sales’

Providing advice and acting between the client and the

provider to arrange a contract for the provision of

financial services, whether or not it is completed.

Exempt

Discretionary (Portfolio)

investment management

A securities-based asset management service, whereby

the adviser on his own discretion takes decisions on the

purchase and sale of securities and implements those

decisions by buying and selling the securities, and

without obtaining prior instruction from the client.

Taxable

Concept of the door remaining open to Arranging

In most cases the Adviser will be using both the permissions of Advising and Arranging and therefore the supply is exempt as this is intermediation. This is also the case even if the transaction agreed to fails.

Intermediation/Negotiation

Advising onInvestments

Arranging

CustomersSeeking

Financialproducts

ProvidersSeeking

customers

FSA Permissions in use

When the door to arranging is closed or closes

• When the service is very clearly only ever involves the advice permission and the service would never use the Arranging Permission. Examples of this would be when the service clearly offers to provide a Financial Plan but there is no requirement to arrange any product. This would not be exempt. The door was never open.

• Where for some reason the intermediation process cannot be completed e.g. the adviser decided as part of his advice that he is not the best person to do the arranging. The door has now closed and the supply is no longer exempt. The adviser may now set a new piece of supply which will not be exempt e.g. when he recommends a discretionary manager. The adviser in this case is now involved in intermediating a service which is not itself exempt i.e. investment management– the intermediation chain is broken. In this case the discretionary manager is taking on the arranging and dealing role.

But a closed door may open….

Examples

There are numerous examples in the Professional Direction

The Vat treatment in these examples have been discussed with HMRC

The problem area – clients who do not agree to complete a transaction

The client: • Says thanks but no thanks• Dies before a agreeing to go ahead• Otherwise falls out of the process before

agreeing to the transaction of any product or financial services

This is not uncommon in other industries – the VAT treatment set at outset can be changed by the REALITY of what was consumed.…………………………………………………………………………………………….Ask your printer

3.13 What if my customer pays everything but the VAT?If your customer refuses to pay the VAT charged, or you did not charge VAT when the supplies were made but issued supplementary invoices to recover the VAT from your customer, the claim to relief is limited to the VAT element of the total debt. For example if you originally charged £100 which your customer paid, and you unsuccessfully attempt to recover the £17.50 VAT charge originally omitted, you are only entitled to claim the VAT fraction of £17.50 as bad debt relief.

2010/12: Retail Distribution Review (Adviser Charging) Instrument 2010per hour We will tell you if you have to pay VAT.” “Lump sum We will confirm what we will charge you in writing before beginning work … We will tell you if you have to pay VAT.” “Reviews We will confirm what we will charge you in writing before beginning work … We will tell you if you have to pay VAT

Practical Issues

• A standard form of assessment of the VAT treatment should be utilised by advisers and kept as part of their file record

• Advisers should set out in their engagement letter to clients the VAT treatment of the supply that they are about to propose to deliver

• Clients should be advised that if they do not agree take up the recommendations, VAT may be charged

• If the client agrees to take up the recommendations the service is exempt – even if the product sale is not finally concluded

Other issues

• ACF – not always appropriate

• Broken ISAs

• Pensions

• Platforms/Wraps

• Regular savings vehicles

Where are we now?

• Guidance issued by HMRC

• Most of our work will be exempt

• Professional Direction by PFS

• However there are issues – surrounding people who do not complete a product transaction – HMRC have taken a position!

CONCLUSION

• Achieving the right VAT outcome should be part of professional excellence.

• Clients who do not agree to a financial services transaction will have to be invoiced directly (outside ACF) for the VAT.

• As with all tax treatments - may be subject to legal challenge

• There will be anomalies to figure out