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Withholding tax on Trailing Commissions and Rebates of Management Fees

Trailing Commissions could be subject to Withholding Ta

Trailing Commissions could be subject to Withholding Tax

A finding in a case in the United Kingdom (UK) that trailing commissions paid by fund platform providers to their clients should be subject to withholding tax may also have implications for intermediaries, fund managers, and insurance and pension providers in Ireland.

In this article, Gareth Bryan, KPMG partner, looks at the facts of this case and considers whether parallels can be drawn with similar commission, loyalty or bonus payments made by intermediaries in Ireland to their clients.

Background

On 9 August 2019 the UK Upper Tribunal overturned a decision of the First- Tier Tribunal in the case of HMRC v Hargreaves Lansdown Asset Management Limited. The UK Upper Tribunal has a status similar to the Irish High Court in that findings by the Upper Tribunal on tax cases can set precedent that applies to other taxpayers.

The case arose in connection with loyalty bonus payments made by Hargreaves Lansdown, a financial intermediary, to retail investors who invested in funds through the Hargreaves Lansdown platform.

Hargreaves Lansdown did not charge its clients a separate fee for using its platform. Instead, it negotiated a rebate from underlying fund managers which was based on the level of the annual management charge earned by the manager with respect to the investors holding their interests through the Hargreaves Lansdown platform. Hargreaves Lansdown retained a portion of this rebate but used some to pay a loyalty bonus to its clients (the investors).

Her Majesty’s Revenue Commissioners (HMRC) contended that these loyalty bonus payments were ‘annual payments’ and, consequently, should have been subject to withholding tax. Hargreaves Lansdown rejected this contention.

Annual payments

The meaning of ‘annual payment’ is not set out in UK or Irish legislation though its meaning has been considered in a number of cases. Most of the relevant judgments are from UK cases and while some of these do not have binding authority in the Irish courts, they would have persuasive authority.

In broad terms, the relevant case law indicates that for a payment to be considered an ‘annual payment’, it would need to have the following characteristics:

  • The amount would need to be paid under a legal obligation (this could include a contractual obligation, a regulatory obligation, or a situation where a counterparty would be able to place reliance on representations made to it).
  • The payment must be capable of recurrence e. it must be possible that it may occur on more than one occasion.
  • The payment must be in the form of ‘income’ as opposed to ‘capital’ payment.
  • The payment must represent ‘pure income profit’ in the hands of the recipient.

On this last point, there is no legislative definition of ‘pure income profit’. Again, its meaning must be considered in light of various judgments. In broad terms, these indicate that a payment would be considered ‘pure income profit’ in cases where the recipient of the income has not incurred any costs or expense in generating the income.

Judgment

In the Hargreaves Lansdown case, the First-Tier Tribunal ruled that all of the above-mentioned characteristics of annual payments were present except that of the loyalty bonus being ‘pure income profit’ in the hands of the investors. Consequently, the Tribunal ruled that withholding tax was not applicable.

HMRC appealed this decision to the Upper Tribunal which has now found in their favour. The judgment was based on a number of findings in relation to the commercial arrangement, including:

  • It is the fund which has the liability to pay the annual management charge to the manager. The investors are legally separate from the fund. Although they economically bear the cost of the annual management charge (in the form of a reduction in value of their investment in the fund) they, themselves, do not incur this cost.
  • Investors introduced by Hargreaves Lansdown to the fund bear the economic impact of the annual management charge irrespective of whether any rebate in respect of that charge is negotiated between Hargreaves Lansdown and the manager (inasmuch as the value of the investors’ investment is reduced by virtue of the fact that the management charge is paid). However, this is true for all investors in the fund.
  • The rebate paid by the fund manager to Hargreaves Lansdown is, in substance, a commission payment by the fund manager to Hargreaves Lansdown in return for placing its funds on the Hargreaves Lansdown platform and promoting them to its clients. The payment of this rebate does not reduce the annual management charge economically borne by the investors.
  • To receive a loyalty bonus, the investors only have to hold the relevant investment at the end of a prescribed period. There are no other requirements that the investor needs to meet in order to receive that payment.
  • The loyalty bonus is paid by Hargreaves Lansdown and not by the fund or the fund manager.

On the basis of the foregoing, the Upper Tribunal found that the investors did not incur any expense in earning the loyalty bonus and that, consequently, it had the character of ‘pure income profit’. On this basis, the payments were held to be annual payments and therefore subject to withholding tax.

Application in Ireland

The law on the application of withholding tax on annual payments in Ireland and the UK has diverged somewhat over the years. Under Irish tax legislation, withholding tax at a rate of 20% should be applied in respect of annual payments (other than yearly interest or patent royalties) paid by an Irish company. Unlike in the UK, no distinction is made between Irish tax residents and non-residents.

Consequently, the finding that trailing commissions may constitute annual payments is potentially significant for Irish platform providers, fund managers, and insurance and pension providers (as the ruling would have persuasive value in the Irish courts) as well as their clients.

While HMRC has actively and publicly pursued this question in the UK in recent years (such as the above-mentioned Hargreaves Lansdown case), to date the Irish Revenue Commissioners have not issued any public guidance on whether or not they consider trailing commissions or similar payments to constitute annual payments subject to withholding tax. This judgment might prompt them to do so.

If you have any questions about the potential impact of the finding in this case on your business, please do not hesitate to contact Gareth Bryan via this form.

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