This week, an Advocate General gave a landmark opinion that the VAT exemption for the management of certain special investment funds can apply to property management, as well as to other fund management services. The opinion represents a completely different approach to that taken in historic VAT cases, which define management for the purposes of the VAT exemption, broadly, in line with the UCITS Directive and have not considered property management.
While it still needs to be seen whether the Court of Justice of the European Union (CJEU) will actually follow the opinion, if it does, it would alter the traditional landscape of the structuring of real estate funds, as EU jurisdictions would be obliged to follow the CJEU’s decision.
Special investment funds
The opinion, however, extends only to a Member State’s special investment funds. What constitutes such a fund must be defined by each Member State and, in the UK, they are those included in Group 5 Schedule 9 of the Value Added Tax Act 1994: broadly, to date these are FCA regulated funds (which include property funds) and certain closed-ended listed investment companies.
The Advocate General states in her opinion that, although the CJEU itself has not stated as such, its jurisprudence is based on the fact that the VAT exemption for the management of special investment funds is reserved for investments which are subject to specific state supervision (and not merely to UCITS funds). While it is not clear precisely what such supervision is, it is assumed at this stage that it covers the sorts of funds which are currently included in the UK VAT legislation. If the CJEU follows this opinion, it is hoped that further clarification would be given on this point.
The main beneficiaries of the case, if the opinion is followed by the CJEU, will be funds operating in sectors such as residential, health care and student accommodation, where property management fees (including for day-to-day property management) at present give rise to irrecoverable VAT. In the UK, this cost is 20% of the relevant fees, which materially reduces returns. Such a change would, therefore, be likely to be warmly welcomed by both fund managers in these sectors, who are currently competing at a VAT disadvantage with others (who invest in taxable real estate) for investors’ money, and by the investors themselves, whose returns should immediately be enhanced.
Potential adverse consequences
However, more widely, if the CJEU follows the opinion, there will be potentially adverse ramifications for commercial property funds and their fund managers and day-to-day property managers, as the exemption on property management fees would then extend to these management fees as well, notwithstanding that there is generally no actual VAT leakage as things currently stand.
Managers, who would be making exempt, rather than taxable supplies if the opinion is followed, will need to consider carefully how this could affect their own VAT position. In particular, we expect that they would wish to reconsider their contracts and balance carefully their ability to re-price and/or make claims for overpaid VAT with commercial considerations.