01/11/17

Britain’s Taxman Wants to Make Money from MiFID

(Bloomberg) -- Banks and money managers are waiting to hear if one of life’s certainties -- taxes -- will apply to investment research payments under MiFID II.

As the clock ticks down to the Jan. 3 start of the European Union’s revised Markets in Financial Instruments Directive, the British taxman has been meeting with industry groups to discuss tax issues related to the law, a spokesperson said. Lawyers said they expect Her Majesty’s Revenue and Customs to publish guidance on applying value added tax to research payments soon.

At issue is a key requirement in MiFID II for asset managers to pay brokerages for stock and bond research rather than receiving it as part of a bundle of services, including trade execution, which tends to make it VAT-exempt. As a separate service, research can be hit with U.K. VAT of 20 percent. And that could force some firms to scale back.

“Asset managers will not increase their research budgets to accommodate VAT charges, so any VAT amounts due on research will simply drain a portion of the budgets, putting even less in the pocketbooks of research producers,” Sanford Bragg, a principal at Integrity Research Associates, said in an interview. “It’s going to effectively magnify the decline in what research producers receive.”

The last-minute tax question is adding an extra wrinkle to years of preparations for a law that could ring up more than $2 billion in compliance costs across the industry. MiFID II is forcing fund managers to take a hard look at how much research they need and possibly to pare back, a change that could take a toll on banks’ revenue and analysts’ jobs.

Brokerages including Goldman Sachs Group Inc. and Exane BNP Paribas have told fund managers that research prices exclude VAT, according to the pricing documents seen by Bloomberg.

“Six months ago people were hoping the U.K. Revenue would take a position that limited the VAT impact of the changes,” said Will Smith, a London-based partner at Sidley Austin LLP law firm. “However, people now accept that exemptions may not be fully available and are gearing up, trying to understand what it means in cash terms. As we come to the end of the year and the impact of the regulatory changes, people are focused on it.”

Taxpayers are waiting to receive guidance, which is of “significant importance,” according to Martin Shah, partner at Simmons & Simmons law firm in London. The Association for Financial Markets in Europe, one of the biggest lobbying groups for brokerages and money managers, has discussed the tax policy with HMRC, the industry group’s spokeswoman said.

The exact toll of any new tax policy will depend on how fund managers are structured and whether they can recover tax liabilities in other ways. While U.K. VAT rates are set at 20 percent, companies are able to recover part or all of their bill depending on the types of services they provide.

Irrecoverable VAT taxes accounted for the second largest chunk of tax paid by the financial industry in the U.K., trailing only employment and insurance levies, according to City of London Corporation data as of end-2016. The study found that the amount of irrecoverable VAT tax for financial firms has increased by 75 percent in the nine years the survey has been run.

“Some investment managers will be able to recover 100 percent of the VAT they suffer. Others may not,” Sidley Austin’s Smith said.

For example, U.K. hedge fund managers will probably be able to reclaim VAT because they provide services to offshore funds or managers, such as those in the U.S. or Cayman Islands.

“If you look at the hedge fund clients, they are fairly unconcerned because they expect to get any VAT that might be charged back,” said Shah of Simmons & Simmons. “If you’ve got aU.K. fund manager managing U.K. retail funds this would, however, clearly be a bigger issue for them.”

Even if firms face less than the full 20 percent rate, Bragg said it will still be consequential for the research industry.

“It is hard to gauge what the net impact of VAT will be, but even if the ultimate charge averages only 4 percent, it is still an extra 4 percent that has been drained out of the research wallet,” he said.