Taxation of loyalty payments - HMRC vs Hargreaves Lansdown Asset Management

All tax advisers are aware that case law relating to the VAT treatment of loyalty schemes over the last ten years has caused complications for many clients with perfectly straightforward commercial promotion and loyalty recognition arrangements. The Upper Tier Tribunal in HMRC v Hargreaves Lansdown Asset Management [2019] UKUT 246 has complicated the picture further in the context of loyalty rewards by overruling the decision of the First Tier Tax Tribunal (FTT). It determined that these may, at least in some circumstances, be annual payments, and therefore subject to withholding tax.  

Key Facts

The Financial Conduct Authority (FCA) in 2014 had made changes in the rules applicable to commission to create a transparent charging structure as part of the Retail Distribution Review. This case concerned both the pre-April 2014 arrangements applied by Hargreaves Lansdown (HL) and its post-April 2014 arrangements, which were changed following the Review.  

The First Tier Tribunal (FTT) had found as facts that, before April 2014:

• HL benefited customers investing through its platform by negotiating lower annual management charges with fund managers; 

• the differences between this lower rate and the “standard” fund management charge was rebated by fund managers to HL; 

• HL kept part of the rebate and passed the balance to customers in the form of a loyalty bonus, and 

• the amount of the loyalty bonus was, contractually, discretionary and could be withdrawn at any time although in practice HL operated specific criteria for payment to customers.

The FTT also found as facts that after April 2014: 

• HL instead passed on the whole amount of the annual management charge rebate applicable to each investor by reference to his/her funds invested on the HL platform, (as it was required to do from a regulatory perspective following the Retail Distribution Review);

• the investor separately paid a platform fee to HL, but

• formally, the table of investor charges did not show the separate platform fee. 

Legal Issues

The question was then whether the rebate, under either set of arrangements, met the conditions to be an annual payment, and should therefore be subject to withholding tax. The judgement of the FTT had been that the amounts due to the investors did not constitute “pure income profit”, and therefore could not be annual payments. In fact, it held these amounts were not “profit” of any description, but rather a reduction of the investor’s costs, and that it was not for HMRC to unpick the various components of the fund flows, thereby isolating one element which could be treated as a pure profit.

The Upper Tier Tribunal, however, decided that it needed to review the overall contractual arrangements in order to determine the appropriate tax treatment. Somewhat controversially, although HMRC had not led evidence to allow the FTT to make findings about whether it was the investor or the fund which was obliged to pay the annual management charge, the Upper Tier Tribunal decided it could fill this gap from its own knowledge.

The funds involved were OEICs, unit trusts or Luxembourg or Irish OEIC equivalents. Based on the UK Collective Investment Schemes sourcebook and the understanding of the two Tribunal members that there was similar provision in Luxembourg and Ireland, the Tribunal held that the only piece of direct evidence given at the FTT on the point was in fact wrong. Accordingly, a finding of the FTT that it was the responsibility of the investor to bear the charge, did not, in the Upper Tier Tribunal’s judgement, amount to a finding of fact that the charge was payable by the investor. It also disregarded the FTT’s conclusion that all investors on the platform would, or should, have understood that the annual management charge suffered would, effectively be, reduced by the loyalty bonus.

This interesting piece of judicial footwork allowed the Upper Tier Tribunal to reconsider the arrangements afresh from a contractual perspective. In doing so it appeared to disregard, however, the terms of the relevant HL factsheet (which might have been held to give rise to representations). It concluded as follows:

• The contractual obligation between the fund manager and HL was for the fund manager to pay to HL the rebate in exchange for its role as platform provider. 

• It was HL’s choice how much of this it passed on to clients, and the fund manager had no contractual right to influence this. The regulatory requirements which meant that post-April 2014 HL was in fact required to pass on the whole amount to investors were not given weight. 

• Therefore, both before and after the April 2014 regulatory changes, the loyalty bonus should not be treated as a cost reduction for investors. 

The Tribunal was unconvinced by the argument that there was a unilateral contract by HL, under which the loyalty bonus was payable to the investor only if certain conditions were satisfied (including the investor meeting the annual management charges). 

For reasons which are not entirely clear from the judgement, a potential argument that the bonus should instead be construed as a reduction of the platform fee was not advanced for the taxpayer. 

The Tribunal therefore considered that the loyalty payments were therefore not cost reduction or discounts and did not require expenditure by the investors to receive these, but were pure income profit in their hands.

The Tribunal’s approach involved disregarding the overall commercial matrix, and the terms on which the arrangements had been marketed by HL, and construing the contracts narrowly. The Tribunal did not appear to address any potential questions of collateral contract or representation. 

Its decision appears to have been influenced by a hypothetical example involving the treatment of bonuses in the context of a second class of shares, without consideration of how common, for retail investors, this scenario actually was, or the ability to achieve a level playing field by other means. 

In considering whether the payments had the quality of recurrence, and therefore could satisfy another of the requirements to qualify as annual payments, the Tribunal adopted a different approach.  It first embarked on a consideration of the approach of the courts when determining whether interest is yearly, citing the Supreme Court judgement in HMRC v Lehman Brothers [2019] UKSC 122. There, the Supreme Court had reasserted the principle that the question of whether interest is yearly needs to be determined based on a commercial, or business-like, perspective rather than simply by reference to contractual terms. The Tribunal then translated this approach to the question of recurrence from an annual payments perspective.  The fact that HL could terminate the loyalty payments, or that they would terminate if funds were withdrawn was not considered relevant.  No evidence was led, for example as to the average life of investments and the Tribunal appeared to consider that none was necessary. The fact that payments would continue to be made for so long as funds were held on the platform appears to have been sufficient for the Tribunal to conclude that the payments did have the quality of recurrence.

It appears to have been accepted by both parties that the other two criteria for receipt to qualify as an annual payment – first, that it is payable under a legal obligation and, second, that it is income rather than capital in the hands of the payee – were satisfied.

We understand that Hargreaves Lansdown has announced that it is, reluctantly, accepting the ruling.

Practical implications

Practical points to note from this decision include the following:

• Unfortunately, commercially straightforward customer incentives can have unwanted direct as well as indirect tax consequences. 

• The treatment not just of platform incentives but loyalty payments and discounts in other contexts should be carefully reviewed. The detail of the contractual arrangements relating to such incentives may turn out to be very important.

• It was particularly disappointing that no difference was found between the position before April 2014, when there was no regulatory obligation to pass on rebates, and the later periods, when this became mandatory. It was also surprising that a rigid, and unacknowledged, distinction was drawn by the Tribunal between contractual provisions (to which considerable weight was attached) and regulatory requirements (not considered relevant).

• Where there is uncertainty, the time taken for disputed treatment to surface and be resolved means that the amounts at stake ramp up – the periods in dispute here started in 1 April 2013.

• HMRC may be hawkish in challenging technically uncertain positions that do not accord with its published guidance. HMRC Brief 4/2013 had set out HMRC’s approach to the treatment of what it described as trail commission, and from the references to trail commission in HMRC’s arguments, it appears that one factor influencing the challenge may have been that HMRC considered that it had made its position clear in the Brief.

• Fundamental tax principles can come back in unexpected forms – annual payments are of much less significance than they used to be in the UK tax system, but older principles can still come back to haunt new commercial arrangements.

• It can be difficult to predict in the current climate when courts will construe contractual arrangements strictly and when tax conclusions will be based instead on commercial reality. In this case the taxpayer appeared to be caught between conflicting approaches on two different points of analysis.

• However, making sure that the tax implications of the contractual terms have been addressed early on is likely to help achieve alignment between tax and practical commercial objectives.