Summary: Hargreaves Lansdown (“HL”) has defeated HMRC’s claim for withholding tax at 20% on platform “loyalty payments” made to its clients, largely pre-2014.The First-tier Tribunal decision, which is likely to be appealed, rests on the Tribunal’s reading of HL’s marketing materials and investor terms and conditions. Other platform providers still making “loyalty payments” may consider reviewing their investor-facing material in light of the decision.

Platforms and “loyalty payments”

HL offered retail investors the ability to use its “platform” to make and manage investments. “Platform” is a word with many meanings – HL’s platform was a service provided through a webpage or an app that:

  • permitted HL’s customers to buy and sell investments, generally in collective investment funds, and
  • provided custody for the investments they bought.

Before 2014, HL’s customers did not pay HL for using this system - on the contrary, HL paid its customers “loyalty payments” for using it. Importantly for the case, the “loyalty payments” indirectly came from the clients’ money:

Clients invested in various “funds” (eg OEICS, authorised unit trusts).

  • Each fund paid an investment manager (“manager”) an annual fee, which at the time typically was an amount equal to about 1.5% of the fund’s assets, for managing its investments and for marketing/distribution.
  • The managers paid (“rebated”) a proportion of these fees to HL for HL agreeing to make their funds available on its platform.
  • HL retained an amount out of these rebates to run the platform and make a profit, and paid the balance to its customers as “loyalty payments”.

Moreover, HL’s marketing materials made clear to their investors that:

  • investing in the funds listed on the platform would involve the payment of an ongoing management fee (ie the 1.5%), and
  • if they invested in and continued to hold their investments through the platform, they would be entitled to receive “loyalty payments”.

The Tribunal agreed with HL that investors would have less regard to the legal niceties of how the management charge might be paid (ie paid by a vehicle they owned shares in to a manager) and more regard to the fact that it was borne by them.

Annual payments and “trail commission”

In March 2013, HMRC had published a Business Brief announcing their new view that payments of “trail commission” “by fund managers, fund platforms, advisers, or any other person acting as an intermediary between the fund and the investor” were potentially “annual payments” falling within s683 of the Income Tax (Trading and Other Income) Act 2005 (“ITTOIA 2005”), and accordingly when paid to UK individuals (amongst others) should only be paid after withholding for tax under s901 ITTOIA 2005. HMRC considered this treatment should apply to HL’s “loyalty payments”. This would require HL to pay 20% of the “loyalty payments” over to HMRC, thus reducing the amount received by its clients.

A payment has to satisfy 4 conditions to be an “annual payment”. The Tribunal quickly agreed that three of these conditions were satisfied:

  1. Income in nature: HL conceded the “loyalty payments” were income in nature.
  2. Paid under a legal obligation: The Tribunal held that HL was contractually obliged to make the payments to its customers.
  3. Capable of recurrence: The Tribunal explained this was a broad requirement, only requiring that the payments were capable of recurrence, and could continue beyond a year. This condition was satisfied on the facts.

“Pure income profit”

The final condition is:

  1. “Pure income profit”: The payments must also be “pure income profit”, that is, a payment that by its nature would be “pure profit” in its recipient’s hands.

Whether the “loyalty payments” satisfied this final condition represented the real battleground between the parties.

This idea of “pure profit” is easiest to understand when the recipient is a trader, such as HL. HL was receiving “rebates” from the managers. However, not all of these rebates were profit in its hands - HL’s profits only emerged after subtracting its related expenses, namely the “loyalty payments” and the other costs of running its business. Profit for a trader is receipts less expenses, and the “rebates” were not HL’s profits, they were its receipts. Accordingly, the “rebates” were not “pure income profit” and so were not annual payments.

Where the recipient is not a trader, the Courts ask what the recipient has to do to receive the payment. Minor obligations do not prevent the payment from being “pure income profit”. However, once the obligations become analogous to those which would give rise to deductible expenses if paid by a trader, the payment is no longer “pure income profit” and hence is not an annual payment.

HL argued there were two such obligations to prevent the “loyalty payments” from being “pure income profit”. First, but unsuccessfully, they argued that HL’s customers would have to keep holding their investments through HL’s platform to be entitled to a “loyalty bonus”. The Tribunal held that this was not sufficient.

Second, and the reason they won the case, HL argued that by holding investments through HL’s platform, their customers were liable to suffer management charges with respect to their investments. Investors therefore earned the right to “loyalty payments” by agreeing to pay management charges. The Tribunal accepted this argument and concluded that the loyalty payments were not therefore annual payments.

  • The case arguably turns on the Tribunal adopting a broad commercial approach to characterising the facts, rather than looking at the legal niceties of the situation. If the Tribunal had accepted HMRC’s legalistic view on matters - that HL’s customers were essentially passive, as it was the funds, not the investor that paid the management fee – then it is likely the Tribunal would have accepted the payments were annual payments. As mentioned, the case seems likely to be appealed, and it will be interesting to see the Upper Tribunal’s view on this.
  • Other platform providers might consider reviewing their marketing materials and investor terms and conditions to bring themselves closer to the facts as found by the Tribunal – in particular, that there was a direct linkage between the investor having to bear fees and their right to a rebate.
  • Back in 2013, HMRC’s Business Brief caused consternation in the fund management industry, as rebates etc were often paid to overseas investors. The Government swiftly introduced a statutory instrument to exempt rebates paid to offshore investors in authorised funds (other than PAIFs) and offshore funds from this withholding. This, and the reduced use of “loyalty payments” following new Financial Services Authority (“FSA”) rules in 2014, means the annual payment issue is now less of a concern than it was. However even today, there are circumstances where fund managers may need to take care.