MiFID II: Why DB funds could save from research cost unbundling

As asset managers grapple with the unbundling of research costs from trading costs, EU member states’ tax authorities are deciding how the newly visible service should be taxed.

In the UK, HM Revenue & Customs (HMRC) is expected to publish guidance on the taxation of investment research services “soon”, according to a Bloomberg report today. Other EU jurisdictions are at various stages of deciding how value-added tax (VAT) will apply.

The effect on how much pension funds and other users or beneficiaries of research pay will depend on the type of investment fund used, according to EY.

Jochum Zutt, senior manager at EY in the Netherlands, said: “For example, [for] an investment manager that provides taxable services to a pension fund, separating research would not change the VAT treatment of the supply by the investment manager – it will still be taxable.

“However, the costs incurred throughout the supply chain would reduce as a result of the research being taxable. This is because the broker providing research to this investment manager would be slightly better off compared to the current position, as it would be entitled to recover VAT associated with the research.

“With MiFID II closing in, it is time to start preparing for the potential VAT consequences.”

Jochum Zutt, EY

“Thus pension funds operating schemes that are subject to VAT – eg defined benefit schemes – may expect a reduction in fees.”

The EU’s VAT Directive, which came into force in 2006, includes an exemption for “special investment funds”, Zutt said.

However, where a manager provides such VAT-exempt services, the manager would not be able to recover any tax included in the cost of its third-party research, Zutt continued.

As a result, “it may be beneficial for an investment manager to pass the costs of research on to the client rather than absorbing it as a cost” on the company balance sheet, he said. This would allow the manager to recover VAT, at least partially.

“With MiFID II closing in, it is time to start preparing for the potential VAT consequences,” Zutt said. “Unfortunately, the most relevant question – around the VAT treatment of research – is still out in the open.

“However, it is likely that some member states will apply VAT on research. Companies can start preparing by identifying the administrative burden and identifying the potential to (partially) recover VAT on research.”

So far, the vast majority of managers have declared that they will pay the costs of research themselves.

Of the 120 biggest managers of European institutional assets, as identified by IPE, 45 have so far made public their intentions regarding the payment of third-party research costs. Only Amundi (including its subsidiaries CPR Asset Management and Pioneer) and Fidelity have said they will past the cost on to clients.