- What was this ruling about?
The case concerned three real estate investment vehicles established by a group of pension funds and managed by a management company. The services provided by the management company included both portfolio management and property management. The management company took the position that these services qualified for the VAT exemption. The Dutch tax authorities disagreed. The Dutch Supreme Court submitted the following preliminary questions to the ECJ:
- Can a vehicle that solely invests in real estate – rather than transferable securities like UCITS – be a qualifying investment fund for the purpose of the exemption?
- If so, does property management also qualify as exempt fund management?
The ECJ ruled that real estate investment funds can qualify for the exemption provided they are subject to specific state supervision, but property management does not qualify for the exemption. The specific state supervision condition was raised and addressed by the Advocate General of the ECJ. The Dutch Supreme Court had not asked questions about this.
- Why is the ECJ ruling important?
This ruling is important because it could significantly increase or reduce the VAT costs of managing investment funds or pools. The following examples illustrate this.
Example 1. A real estate investment vehicle invests in commercial real estate. The rents are all subject to VAT. The vehicle has an external manager that provides services similar to fund management services. The vehicle and the vehicle’s manager are not regulated because the vehicle does not qualify as an undertaking for collective investments in transferable securities (UCITS) or as an alternative investment fund (AIF). The VAT to be charged on the management fees is fully recoverable by the vehicle because the vehicle exclusively supplies services, the rents, subject to VAT. The benefit of the exemption not applying to the manager is that input VAT paid on goods or services delivered to the manager is recoverable to a greater extent. This reduces the cost base of the manager.
Example 2. A closed-end investment fund with only pension funds as investors and with an external manager was established in 2010. Under the Dutch regulatory supervision laws applicable until 22 July 2013, no licence was required. The EU Directive on alternative investment fund managers (AIFMD), as implemented in Dutch law, requires managers of these funds (AIFMs) to be licensed as of 22 July 2013, but this requirement does not apply to this fund pursuant to a grandfathering rule on the condition that the fund makes no new or follow-on investments. The investments of the fund do not involve “VATable” supplies of goods or services. This means that neither the fund nor its participants – which do not provide VATable supplies either – can recover input VAT on fees and other costs. If the exemption does not apply to the management fees charged by the external manager, 21% VAT must be charged on those fees. This VAT significantly increases the costs of the fund or reduces the revenues of the manager because it cannot be recovered.
- What is the origin of the “specific state supervision” condition?
The ECJ takes the UCITS regulation – which has been harmonised within the EU since the implementation of the UCITS I Directive from 1985 – as the starting point for defining qualifying investment funds. The ECJ finds that, in addition to UCITS, investment funds which display features that are sufficiently comparable to compete with UCITS also qualify. According to the ECJ, only funds subject to specific state supervision can be considered sufficiently comparable. On this basis, AIFs will typically qualify as well.
- What does “specific state supervision” mean?
The ECJ has not defined the term specific state supervision. In addition to UCITS regulations, the ECJ ruling suggests that regulatory supervision of AIFMs based on the AIFM Directive qualifies as specific state supervision.
However, many AIFMs were not regulated in the Netherlands before the Dutch financial supervision rules implementing the AIFM Directive took effect on 22 July 2013. Hence, the AIFs that these AIFMs manage or managed could probably not benefit from the VAT exemption before that date.
The following types of closed-ended AIFs managed prior to 22 July 2013 are grandfathered and therefore exempt from regulatory supervision:
- AIFs that do not make additional investments after 22 July 2013
- AIFs whose subscription period closed prior to 22 July 2011 and, according to their constitutive documents, will terminate no later than 22 July 2016.
The first type of AIF is not subject to any AIFMD requirement; the second type must comply with AIFMD reporting and asset stripping requirements. The ECJ ruling does not indicate whether grandfathered AIFs can be considered subject to specific state supervision as of 22 July 2013. We believe there are good arguments that grandfathered AIFs also qualify for the exemption, in particular because they display typical features that are identical to non-grandfathered AIFs (see question 3 above). The argument is stronger for the second type of AIF, which must comply with the AIFMD requirements referred to above. However, it remains to be seen how courts will deal with this issue given the unpredictability and inconsistency of the ECJ in applying this exemption.
Subthreshold AIFMs – whose assets under management do not exceed EUR 100 million or, if applicable, EUR 500 million – are exempt from the AIFMD licence requirement and may benefit from a “light” regime that requires registration with the Dutch regulator. These AIFMs are only subject to certain information and reporting requirements. With reference to the arguments mentioned above, we support the view that AIFs managed by these AIFMs can nonetheless be considered subject to specific state supervision. A different view could put these AIFs in a significantly worse competitive position towards AIFs managed by licensed AIFMs, and this defeats the purpose of the “light” regime. Similarly, managers of venture capital funds investing in small and medium-sized enterprises could be subject to specific state supervision when regulated pursuant to the Regulation on European Venture Capital Funds (the EUVECA regime).
Previous ECJ rulings (the ATP and the JP Morgan Claverhouse cases) suggest that pension fund supervision and stock exchange regulations applicable to listed investment funds also qualify as specific state supervision.
Arguably, other forms of regulatory supervision applicable in respect of investment funds and investment fund management could qualify as well.
- Are there other conditions for being “sufficiently comparable”?
Yes. The Fiscale Eenheid X ruling and previous ECJ rulings indicate that, at a minimum, the following conditions should also be satisfied:
- The investment fund must be funded by participants
- The investment fund should operate based on the risk diversification principle
- The investors should bear the investment risks.
AIFs and funds regulated under the EUVECA regime (see question 4 above) will typically satisfy these conditions.
Previous cases have raised the question of whether investment funds that are closed-ended or that are not open to the public or a wide group of investors could still qualify for the exemption. The ECJ ruling in the JP Morgan Claverhouse case indicates that the closed-ended character of funds does not preclude application of the exemption. Further, the ECJ rulings in the Fiscale Eenheid X and ATP cases imply that restrictions to the group of (potential) investors do not prohibit application of the exemption either.
- Which services qualify as “management”?
ECJ case law shows that services qualify for the exemption if they are essential and specific to the management of qualifying investment funds. These services include portfolio management and certain fund administration and reporting services. Depository and custody services do not qualify. In line with current practice in the Netherlands, the ECJ confirmed in Fiscale Eenheid X that property management does not qualify either. The ruling suggests that, when it comes to the qualification of services that relate to the investments held by the investment fund, a distinction must be made between qualifying portfolio management – which include strategic decisions on investment policy and the making and disposal of investments – and non-strategic services in respect of the investments.
- Can the Netherlands unilaterally expand the scope of the exemption?
No. The EU VAT Directive allows member states to define which investment funds qualify for the exemption. The ECJ held in Fiscale Eenheid X that this discretion is restricted by, among other things, the principle of fiscal neutrality and the objectives of the EU VAT Directive, and that on this basis only investment funds subject to specific state supervision qualify. Hence, member states can only expand the scope of the exemption by making currently non-regulated funds subject to supervision. If member states nonetheless allow a wider application of the exemption, they risk enforcement action by the European Commission.
- What are the consequences of the ECJ ruling?
The prevailing view in Dutch practice was that investment funds which are not subject to regulatory supervision could nonetheless qualify for the exemption under certain circumstances. This is supported by the position taken by the Dutch State Secretary of Finance. This position entails that investment funds as defined in the Dutch financial supervision laws qualify for the VAT exemption, without reservation as regards funds that benefit from a regulatory exemption or grandfathering. In addition, in the view of the Minister of Finance, non-regulated funds and asset pools qualify for the exemption if they are sufficiently comparable to an investment fund as defined in Dutch financial supervision law in that they collectively make investments and are collectively exposed to investment risks. The ECJ ruling confirms that these non-regulated funds were not eligible for the VAT exemption. Hence, positions taken in VAT returns or agreed with the tax authorities in a ruling may turn out to be incorrect.
A VAT recapture by the Dutch Revenue Service (DRS) for management services provided to “comparable” non-regulated Dutch funds before the ECJ ruling may violate the principle of legal certainty or breach agreements (rulings) between the DRS and taxpayers.
The key question is how non-regulated funds will be treated going forward. In a number of cases where the ECJ overruled Dutch VAT law policy, the Netherlands did not revoke the relevant policy. This arguably allows taxpayers to claim continued application of VAT-favourable treatment based on the principle of legal certainty. In other cases, the Netherlands has revoked the policy.
- What should you do?
You should analyse the implications for your non-regulated investment funds, including both existing funds and funds that have terminated in the past five years. Assuming that no enforcement action will be taken by the tax authorities before year-end 2015, the years open for re-assessment are 2011 onwards. For existing funds, you should analyse whether alternative structures are available going forward, if needed. This could include, for example, the formation of a VAT group if the manager and a majority investor are part of the same group. You can also see whether your fund structure can be transformed into a regulated fund structure. For example, if an existing fund is grandfathered on the basis of it being open solely to the group companies of its manager, an alternative would be to have a third party investor participate in the fund.
Also, you should verify the contractual allocation of any VAT risks. If the exemption has been applied incorrectly while the management contract states that the fees are exclusive of any VAT, the manager could seek to claim the VAT from the fund.