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Introduction

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The world of banking can cover a broad spectrum of areas that can typically operate under a banking institutions umbrella. Traditionally banking was represented by retail and commercial banking where the main businesses was to provide a sanctuary for individual and commercial savings and at the same time provide loans and finance to individuals and businesses.

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However nowadays, many banks also offer Investment Banking and Private Banking services. Listed below are a number of services provided by the different areas of banking. (The list is not exhaustive)

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Investment Banking

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Investment Banking services are mainly provided to Large Public and Private Companies, Pension Funds, Governments, other Banks and Private Equity etc.

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Services Provided:

• Mergers and Acquisition Advisory - Advising on strategic transactions such as Acquisitions, Mergers, Joint Ventures, Leveraged Buyouts, Business Restructures

• Trading Platforms - That Facilitate the trading of Bonds (debt), Equities, Swaps, Options, Futures,  

• Debt Financing - Bond issuance, Securitisation (Asset & Mortgage Backed securities), Loans, Liability Management 

• Equities (stock)Lending - Acting as intermediary for a company that lends shares for a fee and a company that pays a fee to borrow the shares possibly for shorting.  

• Initial Public Share Offerings - Advising and raising finance for the issue of shares to the general public  

• Debt Underwriting - Arranging and underwriting the issuance of debt 

• Share Underwriting - Underwriting shares during Initial public offerings (basically a guarantee to buy a portion of unsold shares)

• Risk Management - Providing clients with management solutions to better manage interest rate and foreign exchange risks and exposures

• Research - Carrying out general market, micro and macro economic research or specific sector research for clients for a fee

• Commodities Trading - Trading in physical commodities such as Oil, GAS, Electricity, Metals and Precious Metals such as Iron, Nickel, Gold, Silver, Palladium

• Private Equity - The pooling of funds to use to make acquisitions for investment purposes

• Market Data - The provision of real-time electronic data to companies, markets etc, to enable and assist decision making 

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Wealth Management and Private Banking

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Wealth Management and Private Banking is mainly provided to private Individuals and smaller companies.  Services Will include:

• Portfolio Management - Discretionary and Non Discretionary management of client assets

• Private Banking - A package of banking services for affluent individuals with levels of bespoke services for different grades of affluence. E.g. £100K to 500K, £1M to £10M, £10M to £50M etc.  

• International Banking - A package of banking services offered to Expats etc 

• Fund Management - The Management of pooled funds in Unit Trusts, OIEC's or through a fund supermarket owned by the bank or externally

• Model Portfolios - Bespoke portfolios that are designed specifically to achieve the investment goals of a group of clients

• Financial Advisory and Planning - Retirement Planning, Estate Planning, Executor and Estate Administration, Trustee Services, Pensions, Tax Advisory

• Financing - Trade, Real Estate, Boats. Yachts, Private Jets

• Execution Only - Retail share investing

• Credit Cards - Providing credit card services to clients

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Corporate Banking

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Corporate Banking is mainly provided to larger commercial enterprises where turnover exceeds between £5M - £10M.  Some of these services are listed below. 

• Business Banking - Providing business bank accounts to corporate clients

• International and Trade Finance - Providing international import and export financing, letters of credit

• Asset Financing - Providing financing solutions for acquiring cars, boats, planes, property

• Debt Factoring and Invoice Discounting -  Proving working capital solutions by taking over a client's debtors for a fee to provide clients with smother cash flow.

• Inventory Finance - Providing finance to intermediary distributors of trucks, Tractors, Construction Equipment, Cars

• Cash Management - Finding the best return on client cash balances by moving the funds around to get the best rates 

• Foreign Exchange - FX Trading

• Corporate Credit Cards - Providing corporate credit cards to firms

• Business Development loans - Loans to help businesses grow 

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Retail Banking

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Retail Banking is mainly provided to individuals (general public) and small and medium sized businesses. Services include:

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• Traditional Banking - The provision of bank accounts (current and savings) 

• Cheque Clearing - The clearing and processing of cheques with other banks

• Mortgages - The provision of residential mortgages 

• Personal Loans - Loans to consumers to buy cars, domestic appliances, 

• Business Loans - Loans to businesses to fund growth and acquisitions 

• Debit and Credit Cards - Provision of personal Debit and Credit Cards 

• Insurances - Travel insurance, Residential Insurance

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Banking Income 

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Most of the income generated by banks will either be:

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• Fees Received

• Interest Received 

• Commission Received

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VAT Liability of Services Supplied by Banks

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The VAT liability of banking income will depend on:

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• Type of Service being provided to clients and customers

• The Place of Supply of those Services 

• The Type of Client (business or non business) services are being provided to

• The Specific VAT rules governing the services being supplied 

• Whether the Service is to a Branch, a VAT Group member or not 

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The VAT liability will either be:

• Standard Rated (20%)

• Zero Rated

• Exempt

• Outside the Scope

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Type of Service Being Provided

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Financial Services are largely Exempt from VAT under the Financial Services VAT Exemption (VAT Act, Schedule 9, Group 5, 1-9).  As such, many services offered by Banks will be Exempt when supplied in the UK.

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Services that are not covered under the Finance Exemption will be taxable at the Standard Rate (20%) when supplied in the UK by banks and other financial institutions .

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The Place of Supply of Services and the Type of Client

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The place of supply of services as mentioned under the place of supply tab, is determined largely by whether the supply is to a customer or client in business or whether the supply is to a non business customer.

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Business Customer

• Supplies to customers in business (VAT Registration is normally sufficient evidence)

• Supplies to customers that have both business and non-business activities such as charities, local authorities and government departments

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Non Business Customer

• A customer who is not in business

• Private individual 

• Charity, Government Department or other body which has no business activities

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Services Supplied to Customers in Business

• Supplies to clients in business will be covered under the B2B (Business to Business) General Rule and thus the place of supply will be where the customer or client belongs. (Clients Country of Operation). 

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Services Supplied to Non Business Customers 

• Normally supplies to Non business customers under the place of supply rules will be covered under the B2C (Business to Customer) General Rule and thus the place of supply will be where the supplier belongs.  However there are special rules in place for particular B2C services (including Financial Services) that treat the place of supply of those services that would normally be taxable in the UK as being supplied where the customer or client belongs. 

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List of Services Supplied by Banks and their VAT Liability

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As mentioned above, banks provide a broad spectrum of services and below is a list of B2B and B2C services both within and covered by the Financial Services VAT Exemption and those that are not covered.

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Note: The services listed below that are Exempt when provided to clients in the UK are within the scope of the Finance Exemption and the services that are Standard Rated are not.

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Below we have listed the main types of services offered by banks and the VAT liability for each service which depends largely on the type of client B2B or B2C and the service being offered.

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Retail "Day to Day Banking

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The Traditional service offered by banks to the retail sector (general public) of accepting cash deposits and providing advances and loans, cheque processing and clearing to customers where interest in earned by the banks as income is:

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• Exempt when supplied to a B2B and B2C customer in the UK

• Outside the scope of VAT (with recovery) when provided to Non UK B2B or B2C customers.

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Insurance Services

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Many banks will offer insurance products such as home insurance, contents insurance, motor breakdown insurance to its customers. These services will be:

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• Exempt when supplied to a B2B and B2C customer in the UK

• Outside the scope of VAT (with recovery) when provided to Non UK B2B or B2C customers.

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Corporate Finance (Mergers and Acquisitions) 

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This service is mainly offered by Investment Banks and will involve providing Advisory Services in relation to potential acquisitions or mergers between companies. 

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These services are:

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• Standard Rated when provided to B2B and B2C customers in the UK

• Outside the scope of VAT (with recovery) when provided to B2B and B2C non UK Customers

   

Corporate Loans (Including Mortgages)

Corporate Loans can be offered by retail banks to smaller businesses or by banks providing corporate banking services to larger businesses that turnover millions of pounds a year.  

The granting and advancing of credit falls within the Financial Services Exemption and is:

• Exempt when supplied to a B2B and B2C customer in the UK

• Outside the scope of VAT (with recovery) when provided to Non UK B2B or B2C customers.

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Execution Only Share Transactions

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Many banks will offer online trading platforms that facilitate execution only trading in securities such as equities whereby members of the public or companies can buy and sell shares.  

Execution only trading means the bank will act on the clients instruction to either buy or sell shares (with no advisory or recommendations involved) and the VAT liability is as follows:

• Exempt when supplied to a B2B and B2C customer in the UK

• Outside the scope of VAT (with recovery) when provided to Non UK B2B or B2C customers.

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Arranging the Issue or Placement of Securities

Banks (Investment) involved in the arrangement or placement of shares, rights issues, coordination of an issue of shares where there are a number of participants, this service will be:

• Exempt when supplied to a B2B customer in the UK

• Outside the Scope of VAT (with recovery) when provided to a B2B customer

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Safe Custody

Some banks offer safe custody services whereby clients can store documents such as share certificates,  Gold, Silver, titles etc for a fee. 

This Fee is:

• Standard Rated (20%) for B2B and B2C when supplied to customers in the UK

• Outside the Scope of VAT (with recovery) when provided to a B2B or B2C customer

Global Custody

Global Custody may contain safe custody but will include a package of additional services such as the collection of dividends, interest etc. 

Where the service contains additional activities as described above along with safe custody, then the VAT liability will be:

• Exempt when supplied to a B2B and B2C customer in the UK

• Outside the scope of VAT (with recovery) when provided to Non UK B2B or B2C customers.

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Nominee Services

Nominee Services whereby client shares will be held in the name of the bank on behalf of them.

These services are:

• Exempt when supplied to a B2B and B2C customer in the UK

• Outside the scope of VAT (with recovery) when provided to Non UK B2B or B2C customers.

Stock Lending

Stock lending describes a situation where one person, the ‘lender’, transfers to a second person, the ‘borrower’, the legal title, along with all the dividends and rights, to securities. The borrower agrees to return to the lender, at a later date, an equivalent number of the same securities as those received. 

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Stock lending is :

• Exempt when supplied to a B2B and B2C customer in the UK

• Outside the scope of VAT (with recovery) when provided to Non UK B2B or B2C customers.

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Share Underwriting

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Share underwriting where a bank will receive a commission or fee for guaranteeing to buy unsold shares during an Initial Public Offering (IPO) is :

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• Exempt when supplied to a B2B customer in the UK

• Outside the scope of VAT (with recovery) when provided to Non UK B2B customers.

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Note:  Any shares onward sold by the Bank will also follow the same VAT liability as above. 

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Tax, Legal, Accountancy

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Adhoc services that may be provided by some banks or financial institutions are not covered by the Finance Exemption and are thus:

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• Standard Rated 20% (taxable) when supplied to a B2B and B2C customer in the UK

• Outside the scope of VAT (with recovery) when provided to Non UK B2B or B2C customers.

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Portfolio Management

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Portfolio Management services normally offered by the Private Banking or Wealth Management arms of banks for individual clients can be split into discretionary or non discretionary.  These services can be offered either internally or via third party Investment Managers. 

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(Portfolio Management does not fall within the Financial Exemption like the management of funds such as AUT's of OEIC's as the service is not a collective investment where large numbers of clients funds are pooled together and invested)

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• Discretionary Portfolio Management is where the Manager will make investments on behalf of the client based on their goals and risk appetite

• Non Discretionary Portfolio Management is where the client makes their own investment decisions and may take recommendations or advice from the manager but will ultimately decide on the investments the manager should make on their behalf. 

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Normally the Portfolio Manager (the bank) or the external Portfolio Manager will charge an Annual Management Fee which will be:

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• Standard Rated 20% (taxable) when supplied to a B2B and B2C customer in the UK

• Outside the scope of VAT (with recovery) when provided to Non UK B2B or B2C customers.

The Investment manager as part of the contract may apply a transaction charge (commission) for executing trades or buying and selling securities on behalf of the client.   

If these charges as part of the contract are a separate supply of dealing charges, then the VAT liability is as follows:

• Exempt when supplied to a B2B customer in the UK

• Outside the scope of VAT (with recovery) when provided to Non UK B2B customers.

If these charges as part of the contract are bundled together as a single fee for Investment Management, then the VAT liability is as follows: 

• Standard Rated 20% (taxable) when supplied to a B2B and B2C customer in the UK

• Outside the scope of VAT (with recovery) when provided to Non UK B2B or B2C customers.

Model Portfolios

A Model Portfolio Service is a tailor made service designed by an Investment Manager(s) for a group of investors with the same investment aims.  Funds are invested in a diverse range of assets and asset classes with the aim of reducing risk for clients.  This service has traditionally been treated in the same way as normal portfolio Management by applying VAT on fees charged.

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However many portfolio managers are removing VAT from their fees charged to UK clients on the basis of a recent case (Tatton) where HMRC refunded a substantial amount of VAT on fees charged for their model portfolio service on the basis that the funds were pooled similar to collective investments. 

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Futures Contracts - (Financial)  

Financial Futures are standardised derivatives contracts offered by and traded by Investment banks (as Futures Exchange Members) and allow investors to:

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• Speculate on the price movement of an underlying financial instrument (Stocks, Interest Rates, Currencies, Indexes).

• Hedge against the movement of the price of a financial instrument. ( mainly companies that use the future contact as a hedge against to protect their own financial instruments )

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Financial Futures can either be cash or non cash settled.

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Cash settled means there is no actual delivery of the financial instrument at expiry whereas Non Cash Settled means there is actual delivery of the instrument. 

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Futures contracts are highly liquid and can be traded on Futures Exchanges prior to the expiration date. 

 

Income generated by banks from Futures contracts (commission earned by banks) is:

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• Exempt from VAT when sold or traded with counterparties in the UK

• Outside the scope with recovery when sold to a non UK counterparty

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Financial  Forward Contracts

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Financial Forwards Contracts (forwards) are similar in nature to Futures Contracts in that they both require the buyer and seller to set the quantity of a financial instrument and the date of delivery or expiry.  However the major difference between the two is that whilst the Futures Contract is normally a standardised contract traded on a futures exchange, a Forward is a non standardised private agreement between a buyer and seller OTC.

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Note both futures and forward can be traded privately off exchange Over The Counter (OTC).

 

Income /commissions generated by banks as broker to investors in Forward Contracts is:

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• Exempt from VAT when sold or traded with counterparties in the UK

• Outside the scope with recovery when sold to a non UK purchaser

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Financial Options 

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Options are Financial derivatives that are based on the value of underlying securities such as stocks, bonds, currencies and give the buyer the right to buy (call option) or sell (put option) the underlying asset on a specific date and and specific price.  Unlike futures or forwards there is no obligation to actually buy the underlying asset.  As such a premium is paid for the right to buy the options.

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Most options are equity options and are traded on exchanges and if exercised,  settled via centralised clearing houses.

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Income generated by banks trading or facilitating the trading of options is: 

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• Exempt from VAT when sold or traded with counterparties in the UK

• Outside the scope with recovery when sold to a non UK counterparty

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Foreign Exchange Trading (FX) (Spots)      

Banks often act as brokers offering FX currency trading (Spots) to clients and charge commission.

The Income generated will be:

• Exempt from VAT when sold or traded with counterparties in the UK

• Outside the scope with recovery when sold to a non UK counterparty

Research

Banks (investment) often have research departments that compile and sell investment research normally to companies to assist with their investment decisions.

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This research is: 

• Standard Rated 20% (taxable) when supplied to a B2B and B2C customer in the UK

• Outside the scope of VAT (with recovery) when provided to Non UK B2B or B2C customers.

Trading Platforms

Many larger banks may offer trading platforms "dealer systems" to their clients which allows them to buy and trade securities or provides live market data such as share prices or foreign exchange rates. 

Systems that purely provide market data services to users are taxable as follows: 

• Standard Rated 20% (taxable) when supplied to a B2B and B2C customer in the UK

• Outside the scope of VAT (with recovery) when provided to Non UK B2B or B2C customers.

 

Systems that allow users to insert bits and offers for securities and Match the parties anonymously and finalise the deal will be be covered under the Intemediary Exemption and Exempt from VAT.

If the system does not match the parties on an undisclosed anonymous basis then the service will be vatable at the standard rate 20%

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Hire Purchase

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Banks may offer their customers Hire Purchase which allows them to pay installments over a set period for goods such a motor vehicles or washing machines with the option to make a final payment for the goods at the end of the payment term. Where the goods and finance are provided by the bank, then there will be two supplies one of goods and one of credit.

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For the supply of goods, the customer will be charged standard rated VAT at 20% immediately for the supply of the goods and the ongoing supply of credit repayable in installments will be Exempt. 

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Factoring & Invoice Discounting

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Some banks may offer Factoring and or Invoice Discounting to clients.

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• Factoring is where a factoring company (bank) purchases the outstanding debtor balances from a client for a charge and can either be recourse or non-recourse.  Recourse is where the client maintains the responsibility and bears all the risks of debtor non payment.  If the debtor goes bankrupt or the bank can't collect the funds from the debtor, then the client will have to buy back the debt from the bank.   Non Recourse factoring means that the factoring company bears greater risk if a debtor defaults on its debt.  Another feature of factoring is that it means the bank or factor can maintain a credit control facility for the debts and collect the debts directly from the debtors.

• Invoice discounting is where the bank provides a loan against the clients outstanding debtor balance for which the client can draw down against. The Debtor will be unaware that the client is using this facility.

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There can be many charges levied by the factor (bank) some of which may be Standard Rated 20% and others Exempt. Below is a list of the possible charge types and their VAT liability.

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• Arrangement and or Activation Fee - Standard Rated 20% VAT if provided to UK Businesses and Zero Rated if provided to Non-UK business

• Discount Fee or Charge for Credit - Exempt if provided to UK Businesses and Zero Rated if provided to Non-UK business

• Service Charge - Standard Rated 20% VAT if provided to UK Businesses and Zero Rated if provided to Non-UK business

• Non Utilisation of Loan Facility Fee - Exempt if provided to UK Businesses and Zero Rated if provided to Non-UK business

• Early Termination Fee -   Standard Rated 20% VAT if provided to UK Businesses and Zero Rated if provided to Non-UK business

• Funds Transfer Charges - Exempt if provided to UK Businesses and Zero Rated if provided to Non-UK business

• Legal and other Admin Fees - Standard Rated 20% VAT if provided to UK Businesses and Zero Rated if provided to Non-UK business

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Private Equity / Strategic Investments

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Banks can also as part of their business use its own funds along with other corporate clients or individuals to invest (or build up stakes) in external businesses with the aim of holding those businesses for investment purposes. I.e. Capital growth.  Income generated from those investments can be dividends which are outside the scope of VAT or in the case where the bank is actively managing those investments and charging a fee to the other participant, this will be Standard Rated. 

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BANK COSTS AND VAT

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Banks by their nature are not actively trading in physical goods and as such most of their costs will be professional or resource (staffing) related.

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Costs - Plus VAT

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For Banks, VAT will typically be incurred on professional service and IT related costs such as

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• Information Technology

• Software and Software Development

• Virus and Anti Malware Protection

• Hardware such as Computers, Servers, Screens, Keyboards, Mouses

• Telecommunications and Equipment

• Market Data

• Brokerage

• Consultancy Services

• Legal Services

• Electricity

• Administration 

• Furniture and Fittings

• Security

• Property Rental (opted properties)

• Other Asset Purchases for Hire Purchase or Inventory Finance

• Office Supplies

• Exchange Membership 

• Licence Fees

• Exchange Admin Fees

• Exchange Access Fees

• Gate way / Terminal Connectivity

• Swift Messaging

• Advertising

• Sponsorship

• Research

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Costs - No VAT

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Banks will have significant Non Vatable Costs due to the large numbers of staff they employ.

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• Wages and Salaries

• Income Tax and National Insurance

• Bonuses

• Property Rental (non opted)

• Pension Contribution

• Clearing

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Systems and VAT

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Banks may have a variety of systems (especially the larger banks) to record Income and cost and the associated output and input VAT respectively. Most of the time the number of different systems will be dictated by the number of acquisitions the banks have made over the years where they inherit different systems from each acquisition. 

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However many will have core well established market leading systems (Accounts Payable and Accounts Receivable) such as SAP to record and account for VAT on the bulk of their sales and purchases and which can easily be integrated into into Tax Engines to churn out VAT Returns. 

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From a VAT perspective, the most important and critical aspect for systems in today's digitalized world is their ability to apply the correct VAT code to specific transactions and their flexibility for full end to end automation of the VAT Accounting, Reporting and Recovery process.   

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Sales and VAT Reporting 

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Services provided by Banks to their customers (both internal and external) will need to be treated and categorised correctly for VAT to ensure:

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• The correct amount of Output VAT is included on their VAT Returns and paid to HMRC

• The correct amount of VAT is included on sales invoices

• Their Partial Exemption VAT Recovery Rates and Actual VAT Recovery is accurate

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The best way to ensure the accuracy of above is to:

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• Have a highly automated billing system with links to the static data system that stores clients name, type and location / country of operation details  

• Have a digitalised VAT process that auto allocates income to the correct Partial Exemption sectors  

• Have well trained front office billing staff who understand VAT and the differences created by billing to UK vs Non UK customers 

• Have robust controls around the review and authorisation of invoices

• Have a Team of Tax or VAT specialist to monitor, advise and carry out regular reviews of the VAT billing Process

• Have multiple level VAT return reviews and investigate  and seek explanations for any quarter on quarter exceptional variances  

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Costs and VAT Reporting

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VAT incurred by banks on costs is often very significant and as such it will be high on management's radar to ensure:

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• VAT allocation is aligned to cost allocation

• VAT recovery from HMRC is optimised

• VAT is recovered in accordance with the Partial Exemption Method agreed with HMRC

• VAT Recovered is allocated back to the correct business area (Equities, Corporate Finance, Corporate banking, Private Banking etc)

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VAT incurred on costs can be split into:

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• Front Office VAT - VAT that is directly incurred and attributable to specific business areas such as Corporate Banking, Mergers and Acquisitions, Fixed Income Bond Trading, Corporate Loans, Foreign Exchange

• Back Office or Infrastructure VAT - General VAT incurred for all business areas such as IT, Consultancy, Electricity, Security, Administration.

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Partial Exemption Methods and VAT Allocation

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Most banks will be partially exempt in that they provide taxable and exempt services to their clients and as such will have agreed methods with HMRC for allocating and recovering VAT incurred on their costs.

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Note: Partially exempt means that not all of the VAT incurred on costs will be recoverable from HMRC, only a portion.

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These agreements are known as Partial Exemption Special Methods (PESM) and will be different for each bank. They contain precise details of how VAT will be allocated to the different agreed sectors (Equities, Investment Banking, Retail Banking, Derivatives etc) and also how VAT recovery should be calculated. 

 

So the agreements will stipulate how VAT will be allocated.  For example based on the:

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• Firms internal Cost Allocation Methodology

• Business Area Activity

• Business Area Front Office Headcount

• Others

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VAT Recovery

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The recovery of VAT in banks will be based on specific formulas as stipulated in the Partial Exemption Special Method.  Most will be in the following format:

 

VAT Pool  X    Taxable Sales (Standard Rated + Reduced Rate + Zero Rated

 /  Total Sales (Taxable + Zero Rated + Exempt)   = VAT Recoverable %

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Note: The amounts in the above categories can be in the form of sales values, no of transactions, no of sales credits etc and will depend on what is agreed in the PESM

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Looking at the above formula, it can be seen that the level of VAT recovery will be dependent on the ratio of taxable sales to total sales.  

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• The more exempt sales a bank has the lower the VAT recovery

• The greater the taxable sales a bank has the greater the VAT recovery will be.

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