Key VAT issues for Irish Alternative Funds

VAT Compliance for Funds

The default rule in relation to cross border "business to business" supplies of services is that the services are treated as subject to VAT where the customer has established its business. On this basis, the receipt of taxable non-Irish services by an Irish investment fund or fund manager will give rise to an obligation to register, and self-account, for VAT on a "reverse charge basis". The standard rate of VAT applicable to most services is 23%, and there is no de minimis threshold for registration purposes in terms of the value of the non-Irish services received.

The taxable services typically received by funds from non-Irish suppliers which give rise to Irish VAT obligations include legal, consulting and other professional services, advertising, translation, IT, data processing services, licence fees for the use of technology, and the provision of staff. To the extent that the fund is in receipt of such taxable reverse charge services from outside of Ireland, VAT registration should be sought from Irish Revenue. In the absence of an Irish VAT number to provide to service providers established in another EU member state, the fund will incur foreign VAT on such services which is unlikely to be recoverable from the local tax authorities.

In addition to reverse charge VAT, the fund will also incur Irish VAT on services received from Irish suppliers. Certain services received by a fund are VAT exempt in nature and therefore do not give rise to any Irish or reverse charge VAT obligations - such services typically include investment management, administration and distribution services, banking and insurance services. In addition, directors’ fees and certain regulatory fees are not subject to VAT. In order to ensure that VAT risk is managed at the fund level, best practice would be to carry out a review of the nature of the services received from all non-Irish service providers on a regular basis in order to ensure that reverse charge VAT is being captured, and to document the basis for treating any inbound services as exempt from VAT.

As the activities of an investment fund (and its manager) are generally exempt from VAT, the starting position is that Irish VAT (including reverse charge VAT) incurred on services received is a real cost to the fund and cannot be reclaimed from Irish Revenue.

VAT recovery for funds

Despite the fact that a fund's activities are exempt from VAT, there is an entitlement to recover Irish VAT on allowable costs (e.g. audit fees, legal fees etc.) to the extent that the fund is involved in non-EU investment activities (this is commonly referred to as "qualifying activities"). “Qualifying activities” is generally measured by reference to the proportion of non-EU investments held by the fund, however an alternative methodology based on the proportion of non-EU investors in the fund may be permissible in limited cases. 

By way of example, where an Irish fund is wholly invested in non-EU financial assets it will be entitled to full VAT recovery on costs. Post 1 January 2021, as the UK is now a “non-EU” territory for VAT purposes, Irish funds invested in UK financial assets have benefited from an uplift in VAT recovery on costs (where previously there was no VAT recovery entitlement in respect of UK investment activities). 

If the fund does not currently receive any taxable services from outside of Ireland, and as such is not obliged to register for VAT, a reclaim of Irish VAT incurred by the fund in the last four years may still be sought from Irish Revenue, to the extent that the fund is involved in “qualifying activities”.

Scope of the “fund management” VAT exemption

Ireland currently has a business-friendly VAT regime for investment funds. Irish VAT legislation provides an exemption in respect of the management of certain designated “special investment funds”, which includes ICAVs, Common Contractual Funds, Unit Trusts and certain Investment Limited Partnerships, including those set up under the Investment Limited Partnership (Amendment) Act 2020. The exemption also applies to qualifying Section 110 securitisation vehicles.

The definition of “management” for the purpose of the VAT exemption includes services in three broad categories - investment management, fund administration and marketing services provided to a qualifying fund. In the context of Section 110 companies, current practice is that services provided by the collateral manager, portfolio administrator and corporate services provider all typically qualify for VAT exemption.

The scope of the “fund management” VAT exemption is a much debated topic at EU level off the back of frequent European VAT case law and changes in the nature of the services being outsourced by fund managers, particularly in light of digitalisation.

Most recently the Blackrock Investment Management UK Ltd case (C-231/19) explored the question of whether VAT exemption could apply to licence fees for the provision of a fund platform service used by Blackrock to manage both special investment funds and other funds. In that case, the Court of Justice of the European Union held that a single supply of management services provided by the software platform that manages both special investment funds eligible for VAT exempt fund management services and other funds does not fall within the fund VAT exemption. However there is reason to infer from the judgment that where the fund platform services were provided purely in relation to the management of qualifying funds that VAT exemption should apply.

Is there any scope for AIFs to manage their VAT leakage?

Where a management fee is payable to an investment manager established outside of Ireland in relation to the management of a qualifying Irish fund, this is treated as VAT exempt, however it is important to consider the VAT treatment of any recharges of costs by the investment manager to its Irish funds in respect of fund set-up costs and ongoing expenses. While there may be scope to treat recharges of expenses incurred by the investment manager in the course of the provision of its asset management service as a part of a single composite VAT exempt service, this is a complex area and the VAT treatment will ultimately depend on the contractual and invoicing arrangements between the fund, the investment manager and any third party service providers.

From a VAT perspective, Brexit has presented an opportunity for certain Irish funds to reduce their VAT exposure to the extent they are involved in UK investment activities. Prior to Brexit, where a fund invested in UK financial assets there was no right to deduct VAT incurred on related costs, whereas now such UK investment activities carry a right to deduct VAT. To date, no practical guidance has been issued by Irish Revenue in relation to the procedural aspects of this change in VAT recovery status for impacted financial services entities with effect from 1 January 2021. However based on what we have seen so far, we expect an increase in Irish Revenue scrutiny on VAT refund claims for those impacted.

Significant VAT changes could be on the horizon for financial services in general, and the asset management sector in particular as a result of the commencement of the European Commission’s VAT Review for Financial and Insurance Services. 

The consultation process for this EU VAT Review is currently underway and will run until 5 May 2021. We expect there will be a strong push from the European Commission towards taxing financial services transactions in some capacity, with one option being to apply a reduced rate of VAT to fee-based income, including fund management fees. Following the consultation period an impact assessment will be carried out, and the review is expected to lead to legislative changes at some point in 2022.  

While it is very difficult at this stage to determine the direction of travel, the review certainly presents a risk for the fund management exemption in respect of Irish qualifying funds, and PwC are currently involved in discussions with relevant industry bodies who are strongly advocating for retaining the status quo VAT exemption for the sector.

We are here to help you

We hope that this article provides useful insight into the Irish VAT obligations for investment funds and what we believe to be the key areas which alternative managers will need to monitor closely to ensure they are meeting their Irish VAT compliance obligations whilst also benefiting from VAT recovery on expenses and relevant VAT exemptions on services received, where appropriate. As always, should you wish to discuss any of these topics in more detail, in terms of the impact to your business, please do not hesitate to reach out to a member of the team.