Questions on VAT treatment of portfolio management go to European Court
Alain Recoules of Taxand France and Alexander Skowronek of Taxand Germany analyse a German decision that focuses on the VAT treatment of asset management on behalf of third parties.
In a 2010 decision, a German tax court of first instance held that portfolio management under mandate is exempt from VAT. The German Federal Tax Court (Bundesfinanzhof) has now issued its judgment on appeal and has submitted the issues relevant to the case to the European Court of Justice for interpretation in accordance with Directive 2006/112/EC on VAT.
The court of first instance's reasoning, which has been defended for more than eight years , contradicts, for the moment, the position adopted by the German and French tax authorities.
The VAT treatment that is applicable to asset management on behalf of third parties is not harmonised throughout the EU. A distinction can be made between collective management (UCITS), which is exempt from VAT, and management under mandate (individual contracts between the management company and each of its principals), which is taxable.
Undertakings for Collective Investment in Transferable Securities (UCITS) are investment funds that allow any individual or corporate investor to entrust the management of their capital to a professional, who takes responsibility for investing the capital in one or more designated financial markets.
German case law therefore opens up prospects for change in the VAT treatment that is applicable to management under mandate, even if, as is so often the case, this is a fairly long process.
It should not be forgotten that only a few years ago, VAT treatment in France differed within the field of collective management itself, depending on the nature of the UCITS. The management of SICAV (open-ended investment companies) was taxable, unlike the management of mutual funds, which was exempt.
Article 261-1? f of the French Tax Code (Code general des impots), which was in force at the time, provided that the management of mutual funds and special purpose vehicles was exempt. This article transposed article 13 D, D 6? of the Sixth Directive 77/388/EEC of May 17 1977, which exempts the management of mutual funds, as defined by the member states; in the spirit of the directive, this term includes all forms of collective management instruments.
After many years of discussions, for the sake of tax neutrality, in 2005 France aligned its legislation on the VAT treatment of open-ended investment companies with that of mutual funds. Henceforth, article 261-1? f of the French Tax Code exempts "management of UCITS and special purpose vehicles".
"Delegated" management under mandate, on the other hand, has not undergone any developments and is taxable in all cases.
Article 261-1? e of the French Tax Code provides that thesebenefit from exemption:
transactions, other than the custody and management of shares, equity interests in companies or associations, bonds and other securities, excluding documents establishing title to goods and partnership interests, possession of which confers the de jure or de facto benefit of the title to or enjoyment of real property or the fraction of a piece of real property.
This section of the French Tax Code clearly transposes article 13 B, d 5? of the Sixth Directive, which extends the scope of VAT exemption to include "transactions [in shares, debentures and other securities], including negotiation, excluding management and safekeeping".
However, while the letter of the directive explicitly rules out the exemption of securities management, once again it is necessary to bear in mind the spirit of the European lawmakers to understand the directive's full scope. How should we interpret "securities management" within the meaning of the directive?
In its decision of December 13 2001 (CSC Financial Services Limited, Case C 235/00), the European Court of Justice (ECJ) rightly specified that the "transactions in securities" referred to in article 13 B, d 5? of the Sixth Directive should be construed as referring to "transactions liable to create, alter or extinguish parties' rights and obligations in respect of securities".
Therefore, a distinction should be made between different forms of securities management.
It should not be forgotten that what is commonly referred to as management under mandate in fact covers widely differing realities.
Managers can act under a mandate that is more or less extensive. Their role can be limited to investment advice or the execution of orders to buy or sell. However, their role can also be more comprehensive if it includes decisions to buy or sell securities on behalf of principals according to the prudent or aggressive investment profile the principals define for themselves.
Yet, these activities are very different, and there does not appear to be any justification to apply the same VAT treatment to them.
When the managers provide advice or execute their principals' orders, it is indisputable that their remuneration is liable to VAT in accordance with the provisions of article 261-1? e of the French Tax Code referred before, inasmuch as their activity does not entail any change in the legal and financial situation of the parties. This is more of an administrative service, which is ancillary to a deposit and custody service or a securities account holding service.
In contrast, there is no justification for taxation, when the manager has the freedom to make decisions that are binding on the principal.
When the mandate granted to the manager includes the power to bind the principal to purchases or sales of securities, then the manager's action does indeed entail a legal and financial change in the parties' rights.
This is not an activity that is confined to recognising the securities transactions decided by the manager's client in the accounts.
This was the ruling of the Hesse Tax Court in 2010 (decision of the Tax Court of the State of Hesse (Hessisches Finanzgericht [in German]) dated March 22 2010, 6 K 1930/09). The German tax authorities appealed this decision. On February 2 2011, the German Federal Tax Court published its decision of October 28 2010 (V R 9/10), at which point in time the legal proceedings were stayed and the case was submitted to the European Court of Justice for a decision.
In its decision, the Hesse Tax Court needed to decide whether asset management by a bank for a domestic (German) client is subject to VAT. The client had instructed the bank to manage certain assets at its own discretion, subject to the strategy guidelines chosen by the client, and without obtaining any prior instructions, as well as taking all measures that seem expedient for the management of the assets and, to this end, to dispose of and acquire the assets.
As remuneration, the client was to pay a percentage of the value of the managed assets plus VAT on an annual basis. The parties agreed that the flat-rate remuneration would be comprised of a fee for the asset management and of a fee for the acquisition/sale of securities.
The Hesse court decided that the services rendered by the bank can be characterised in part as "negotiations" that do in fact fall under the tax exemption set forth in section 4 No 8 (e) and (c) of the German Value Added Tax Act as amended on February 21 2005 (Umsatzsteuergesetz 2005, or UStG 2005).
The purpose of negotiations for transactions in securities and money claims is to do all that is necessary for two parties to enter into a contract, without the negotiator having any interest of its own in the content. In that regard, the Hesse Tax Court has held that negotiation may consist, for example, in pointing out to one of the parties to the contract suitable opportunities for the conclusion of such a contract, in making contact with another party or negotiating, in the name and on behalf of a client, the details of the payments to be made by either side. By making decisions regarding the acquisition or sale of securities and subsequently representing the investor in its name and on its behalf, the bank did all that is necessary to conclude a contract between the client and the purchaser/seller, and therefore the bank "negotiated" transactions in securities and money claims within the meaning of section 4 No 8 (e) and (c) UStG 2005.
The Hesse Tax Court qualified any services rendered above and beyond this as dependent services ancillary to the actual negotiations. In connection with this, the court pointed out that the view of the Federal Ministry of Finance (Bundesfinanzministerium, or BMF) in its decree dated December 9 2008, which said that the tax-exempt services within the meaning of section 4 No 8 (e) and (c) UStG 2005 were ancillary and the (other) (management) services were deemed to be predominant, was not persuasive as the activities of the service provider (bank), which were focused on the acquisition of optimal assets, are deemed to dominate the agreed upon services as a whole. The asset management services rendered as a whole for individual clients are therefore not subject to tax.
The BMF appealed the decision of the Hesse Tax Court and the Federal Tax Court then stayed the legal proceedings and submitted these issues to the EC J for interpretation:
- Is the asset management of securities ("portfolio management"), in which a taxpayer decides, at its own discretion and in exchange for remuneration, the acquisition and sale of securities and executes said decision by acquiring and selling securities, tax-exempt only as the management of special investment funds jointly for several investors pursuant to Article 135 (1) (g) of the Directive 2006/112/EC or also as individual portfolio management for individual investors pursuant to Article 135 (1) (f) of the Directive 2006/112/EC (i.e. transaction in securities or negotiation for such transaction)?
- When determining main and ancillary services, how important is the criterion that the ancillary services do not represent the actual objective of the clients but are only the means to avail themselves of the main services of the service provider under optimal conditions vis-?-vis the separate charging of fees for ancillary services and the ability to provide such services via third parties?
- Does Article 56 (1) (e) of the Directive 2006/112/EC include only the services set forth in Article 135 (1) (a) to (g) of the Directive 2006/112/EC or does it also include asset management of securities (portfolio management), even if such transactions are not subject to the above-mentioned provision?
The Federal Tax Court justifies its submission to the ECJ by arguing that the court doubts whether the tax exemption of the portfolio management assumed by the Hesse Tax Court and also by the Federal Tax Court in its decision of October 11 2007 (V R 22/04 - BStBl 2008 II S 993) can be derived with sufficient clarity from the directive. The Federal Tax Court holds the view that, under the principle of tax neutrality, portfolio management should not be accorded different treatment than the management of a special investment fund. However, on the basis of the dictate to interpret the provisions of article 135 of Directive 2006/122/EC narrowly, the Federal Tax Court questions whether individual portfolio management can qualify as a tax-exempt transaction in securities.
With regard to another issue raised by the Federal Tax Court: whether in assuming taxable transactions in securities, the individual portfolio management could be viewed as tax-exempt negotiation, the Federal Tax Court doubts whether the managing bank continues to act in the role of intermediary due to the bank's self-interest (see CSC Financial Services Limited, Case C 235/00).
Should the ECJ negate the finding of a tax-exempt transaction in securities as well as tax-exempt negotiation, then the Federal Tax Court must decide whether the tax liability also applies to the acquisition and sale of securities if such services are subject to separate remuneration. This will depend on whether the acquisition and sale of securities will be viewed as a separate service or merely as a dependent ancillary service to the taxable asset management.
Regarding the ECJ's decision in Case C 572/07 RLRE Tellmer Property  ECR I 4983, the Federal Tax Court believes that the issue whether a service qualifies as an independent service because of the separate charging of fees and separate supply of services via third parties requires interpretation, even if such service does not represent the objective but merely serves as the means (that is, the acquisition and sale of securities) to provide the optimum main services (that is, the asset management).
The Federal Tax Court also believes that the issue of distinguishing between main and ancillary services requires interpretation even if the ECJ decides that individual portfolio management is exempt from VAT. In that case, it would need to be determined if, in light of the separate supply of services for the safeguarding and management of securities, such services, which are independent of the tax-exempt portfolio management, would be subject to VAT.
In view of the Federal Tax Court's tendency to lean in favour of finding individual portfolio management to be tax-exempt because of the otherwise unfair treatment of management under mandate vis-?-vis the treatment of collective management in accordance with the principle of tax neutrality, this particular issue will nonetheless have to remain undecided until the issues raised above are resolved by the ECJ. The court's decision, however, could result in opening the way for a positive move towards recognising the VAT exemption of management under mandate when the managers have freedom to bind their clients, as this is a predominant service of negotiation for transactions in securities; the collection and supply of the information required to take the investment decisions are only ancillary services from the principal's point of view.
In France, companies that provide management under mandate services, which are undergoing a tax audit that calls into question the application of the VAT exemption, could usefully bring the German decision to the fore in their defence arguments. Companies that charge VAT on management under mandate services can wait until the German Supreme Court renders its decision before deciding on whether or not it is apposite to file VAT recovery claims.
In Germany, the relevant companies should continue their practice at least until the decision of the Federal Tax Court (on the basis of the ECJ's decision) is handed down. All tax assessment notices should remain appealable until the date of such a decision.
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