The Taxman Cometh


Tax reform is taking the taxes off things that have been taxed in the past and putting taxes on things that haven’t been taxed before. –Art Buchwald

New York—The search for ‘best execution’ is one of the most powerful forces driving the increasing unbundling of research payments from trading commissions.  However, unbundling in Europe and the U.S. is running into a countervailing force: taxes.  Execution costs are largely exempt from Value Added Tax (VAT) in Europe and sales tax in the U.S., but research is not.  As client commission arrangements/commission sharing agreements (CCAs/CSAs) become more widespread in various domiciles, tax implications are also growing.

CSAs are growing quickly in Europe, thanks to ‘best execution’ imperatives contained in the Markets in Financial Instruments Directive (MiFID).  One unintended consequence is the taxation of research.  Most European countries charge VAT on sales of products and services, although rates vary.  In the UK, VAT rates are typically 17.5%, in France 19.6%, in Sweden 25%.  In most cases, financial services, including trade execution, are exempt from VAT.

As CSAs are being adopted across Europe they are triggering questions whether the commission pools set aside for the purchase of research are subject to VAT.  In the UK, there is some comfort that CSAs do not trigger VAT, although there is concern that this situation might change as HM Revenue & Customs (HMRC) examines the matter more closely.  Tax authorities in other domiciles have been silent on the matter, leaving market participants to make their own determinations.  Fund managers in the UK can reclaim a portion of any VAT paid on research, depending on the mix of institutional and retail clients, suggesting that VAT is more an administrative burden than a expense burden.

The tax status of research in the U.S. has also come up.  There is concern that as CCAs create more explicit charges for research, research will become subject to state sales tax.  Sales tax is lower than VAT rates, ranging from 0% to 9.5% but funds cannot reclaim the tax.

Most alternative research, which provides explicit fees for its services, is already taxed.  The taxable status of alternative research does not seem to be slowing its growth with investors.  The question now is whether proprietary investment banking research, as it increasingly is unbundled from execution, will also be taxed.  The answer is still being determined, but, if yes, will not be fatal if the experience with alternative research is any guide.


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