Tax Planning International, December 2013
Luxembourg: New circular announcing that risk management services rendered to special investment funds are exempt from VAT
On November 8, 2013, the Luxembourg VAT Authorities issued Circular No.723 confirming the VAT exemption of risk management services rendered to special investment funds.
The implementation of the AIFMD into Luxembourg law triggered the necessity of amending Article 44(1)(d) of the Luxembourg VAT law. The aim of those amendments is to ensure that all Alternative Investment Funds (AIF) as well as all the companies performing securitisation transactions would be eligible to receive VAT-exempt management services in the same manner as it is the case of the Undertaking for Collective Investment in Transferable Securities (UCITS).
In the AIFMD context, the manager must exercise two functions: the management of the portfolio and the risk management function. The manager may use third party services in order to help him to accomplish his duties.
While it clearly appears from the existing sources of VAT law (i.e. European Jurisprudence, Circular No. 723) that portfolio management services could be considered as VAT-exempt management services of funds, this is not as straightforward for risk management services, the importance of which is constantly increasing in the financial and economic environment. Risk management services could include, for example, determining what the evolution of interest rates could be when a fund borrows with variable rates in order to finance its investments and to increase its return on investment. It could also include the analysis of the risk linked to the evolution of currencies when a fund invests, for example, in US Dollars but is financed in Euros. These are only very simple examples of very complex methodologies.
Indeed, Article 44(1)(d) lists the entities eligible to receive VAT-exempt fund management services. On the other hand, the Luxembourg legislator did not, however, define the scope of those services. Only in Circular No. 723 did the Luxembourg VAT authorities quote the Abbey National case where the Court of Justice of the European Union (CJEU) defined the concept of management services by referring to Annex II of the UCITS Directive which provides for a non-exhaustive list of services. These services which could benefit from the VAT exemption include, most notably, investment management (understood as portfolio management services) as well as administration services.
Circular No. 723 and its implications
In light of the aforementioned Circular, the Luxembourg VAT Authorities have judged it necessary to clarify and confirm that risk management services can benefit from the VAT exemption provided for the management of special investment funds in Article 44(1)(d).
This has been done via Circular No. 723, which is not per se a binding legal instrument for the taxpayer, but expresses the position of the VAT authorities.
Outsourced risk management services
In a case where the fund manager subcontracts a part of risk management services to a third party, the VAT exemption could still be applicable, under certain conditions.
In this respect, Circular No. 723 refers to the Abbey National case, where the Court ruled that subcontracted services could be VAT-exempt if “viewed broadly”, they form “a distinct whole” and are “specific to and essential for the activity of the fund”. In the recently published GfBk case, the Court further clarified that outsourced investment advisory services could qualify as VAT-exempt management services as a result of being “intrinsically connected” to the activity of the fund.
In light of these various elements, it could be considered that risk management services are effectively essential for the management of the funds. Indeed, these services are required by law. Without these services, it would appear that the funds would be unable to manage their investments in line with their investment policies and their risk policies. These services are also specific to the funds because they are not used by all businesses. It should also be examined whether the services qualify as a “distinct whole” or are “intrinsically connected”. Indeed, not all services might be VAT exempt. As a consequence, the delegation of the whole risk management function or at least a substantial part of this function should quite clearly be VAT-exempt while providing access to the software should be considered as liable to VAT. However, between these two extremes, the VAT treatment of some forms of outsourcing might be more difficult to determine. In this case, it would be necessary to carefully examine all the criteria laid down by the CJEU. As with any other text, a Circular could not embrace all potential factual situations especially in a new and developing activity such as the one of risk management for alternative investment funds.
Circular 723 should be much appreciated by the Luxembourg investment fund industry as it ensures a favourable VAT treatment of services of such importance as risk management. Indeed, investment funds have, in principle, no right to recover its input VAT and consequently input VAT incurred on costs become a burden. On the other hand it is also important to keep in mind that the exemption implies that risk management service providers may not recover the VAT incurred on their own respective costs.
Michel Lambion, Partner, EY Luxembourg
Tomasz Marczukiewisz, Senior, EY Luxembourg
 AIFM is the European Parliament’s and the Council’s Directive on Alternative Investment Fund Managers of June 8, 2011.
 Article 44(1)(d) of the LTVA implementing Article 135(1)(g) of the VAT Directive, provides for the exemption of the management of special investment funds as defined by Member States.
 Abbey National, C-169/04, May 4, 2006; GfBk, C-275/11, March 7, 2013.
 The Circular No. 723 released by the Luxembourg VAT Authorities on December 29, 2006.
 Circular 723 also refers to the Circular 723 bis of April 30, 2010 which excludes from the benefit of the VAT exemption outsource services which should be considered as “isolated services”. In the absence of any further details, it seems that this concept of “isolated services” should be seen as a linguistic precision of the concept of “distinct whole”.