Out-Law Legal Update | 18 Sep 2017 | 10:40 am | 4 min. read
Fund management company Blackrock Investment Management (UK) Ltd created a software tool called Aladdin that helped the fund management process.
Aladdin undertakes a host of functions related to fund management. It is described as an integrated trading, portfolio management and risk reporting application. It can capture, execute, process and settle securities transactions and generally facilitate securities trading in order to assist in portfolio management. It also assists with ensuring that each fund meets its regulatory requirements as regards trading. The licencing agreement is clear that Blackrock Fund Management International (BFMI), the provider of Aladdin, only provides the system. The company does not act as an investment adviser or fiduciary.
Blackrock manages a range of funds for varying classes of investor. For VAT purposes some of these funds enjoy Special Investment Fund (SIF) status and so the management of them is exempt from VAT. Other funds do not have SIF status and so bear the burden of VAT on management services supplied to them.
Management of a collective investment fund, whether SIF or not, consists of numerous functions. Key among these is designing and executing an investment strategy to generate the required returns for investors. However, beyond this are numerous regulatory, administrative and accounting functions without which the fund would be unable to undertake its investment business. Previous case law has held that, in the right circumstances, exemption may apply to all of these.
Aladdin is located and owned in the US, but use of it is licensed to Blackrock’s UK subsidiaries, primarily Blackrock Investment Management UK Ltd (Blackrock UK). Blackrock also licenses use of the system to third party fund managers.
A dispute between Blackrock Investment Management and HMRC decided by the First-tier Tribunal dealt with whether or not charges for SIF funds' use of Aladdin were exempt from VAT. The case is interesting as the changing nature of IT and the increasing supply of 'software as a service' requires us to look again at the traditional boundaries of the VAT exemption.
The case turned upon the definition of 'management' for the purposes of the Directive and what functions management entails. The Tribunal examined various authorities including cases involving Abbey National, GfBK, and ATP. It noted the requirement that to be treated as 'management' for these purposes the services in question must be specific and essential to the business of investment management when considered as a whole. The Tribunal noted that the administrative functions listed within Annex II to the UCITS Directive concerning fund management provided an indicative, non-exhaustive list of those functions considered to be specific and essential to fund management.
The Tribunal recognised the conclusion in the GfBK case that it is perfectly possible for outsourced elements of management to be outsourced and still benefit from the exemption. They must be intrinsically connected to investment management business and performed with a significant degree of autonomy in order to satisfy the specific and essential characteristics required for exemption.
HMRC resisted the claim to exemption on the following grounds:
The Tribunal disagreed, finding that the Aladdin services were exempt when they related to the management of SIFs.
The Tribunal said this was because Aladdin automated many tasks which previously had to be undertaken manually. The benefits of this were to reduce support headcount within the business and also to allow each portfolio manager to oversee more funds, thus allowing Blackrock to offer a greater range of investment vehicles. In addition to the functions undertaken by the Aladdin system, BFMI staff worked with data on the system as part of the Aladdin service.
The Tribunal addressed HMRC’s point concerning none of the services forming a distinct whole, which was specific and essential to fund management. Judge Brannan rejected the notion that the outsourced service needed to be significant or substantial to meet the specific criterion. In deciding whether the services met the 'distinct whole' test, the Tribunal held that the test could be satisfied by considering the totality of the services provided by Aladdin during the investment cycle, rather than applying the test to each element independently.
The Tribunal rejected the claim that Aladdin was simply a mere material or technical supply of making available an IT system. As in the CJEU’s judgment in a case involving SDC, the manner in which a service is delivered is irrelevant. The correct test for exemption is functional in nature, ie what is actually done. In that regard, the functions undertaken by Aladdin were intrinsically connected to fund management. The argument that Aladdin could not satisfy the exemption test because it is a mere tool is not the appropriate test.
The Tribunal was not convinced by HMRC’s argument that there was little distinction between some of the functions undertaken by BFMI/Aladdin and those still performed by Blackrock UK. HMRC’s contention being that in the GfBK case, advocate general Cruz of the CJEU had spoken of the need for 'distinctiveness' between outsourced services and those performed by the recipient. The Tribunal considered this point to be misunderstood, stating that there seemed to be no reason why a company should not benefit from the exemption if it decided to outsource accounting for some funds but not for others.
Although Blackrock won on the exemption issue, it failed to benefit from this victory. The secondary point had concerned apportionment of the services between SIFs and non-SIFs. Blackrock accepted that the Aladdin services were a single composite supply, but had argued that it should be possible to apportion the fee such that VAT was due on the non SIF element and exemption applied to the SIFs.
The Tribunal held that the general principle was that a single rate should apply to a single supply except in very specific circumstances, none of which applied in this case. Therefore, as non-SIF vehicles predominated the entirety of the supply fell to be standard rated.