In recent years, the UAE has become a hub for fund management and investment activities, thanks to its favourable regulatory environment. A recent report published by Global SWF has also revealed that Abu Dhabi is the global leader when it comes to the value of its sovereign wealth funds, overtaking Oslo and leading Beijing, Singapore, Riyadh and Hong Kong.
This article provides an overview of fund structures in the UAE and explores how recent changes in VAT legislation will impact fund managers and their fee structures.
Fund Regulatory Framework in ADGM and DIFC
The UAE offers two primary regulatory jurisdictions for fund managers and investment funds: the Abu Dhabi Global Market (ADGM) and the Dubai International Financial Centre (DIFC). Both ADGM and DIFC are financial free zones designed to facilitate global investments while providing robust regulatory frameworks.
In the ADGM, funds are governed by the Financial Services Regulatory Authority (FSRA), which offers various fund structures, such as Qualified Investor Funds (QIF) and Retail Funds, aimed at catering to different investor profiles and capital-raising needs.
Similarly, the DIFC, regulated by the Dubai Financial Services Authority (DFSA), offers a flexible yet stringent framework for fund management, allowing for structures like Public Funds, Exempt Funds, and Qualified Investor Funds. These zones offer fund managers a high degree of regulatory certainty and flexibility, coupled with advantageous tax treatments that attract international investors to the UAE market.
Overview of Fund Structure in the UAE
In the UAE, funds are typically structured with a General Partner (GP) and Limited Partners (LPs). The GP is responsible for managing the fund, making investment decisions, and assuming liability. Meanwhile, the LPs are typically passive investors, providing capital but having limited involvement in the fund’s day-to-day activities.
The fund itself invests in various asset classes, including real estate, equities, bonds, and private equity, depending on its strategy, with the intention of generating profits for the LPs. These funds may be domiciled within or outside the UAE.
Role of the Fund Manager
A fund manager plays a pivotal role in managing the fund’s investments. The fund manager provides services like investment management, advisory services, compliance, and monitoring. They make decisions on behalf of the fund, aiming to maximise returns for investors while managing risk.
Calculation of Fees
Fees charged by fund managers usually depend on two main components:
Current VAT Position
Until recently, the VAT rules in the UAE were relatively straightforward for fund managers:
- Management Fees: Typically calculated as a percentage of the total assets under management (AUM), these fees cover the fund manager’s services related to investment advice and administrative support.
- Performance Fees: These are linked to the fund’s performance, usually as a percentage of profits above a certain benchmark. The performance fees incentivize the fund manager to deliver returns that exceed the expected level.
- If a fund manager in the UAE provides services to a fund within the UAE, they charge 5% VAT on the fees.
- If a fund manager in the UAE provides services to a fund outside the UAE, they can apply zero-rated (ZR) VAT, provided certain conditions are met.
VAT Changes and Their Impact
A significant change in the VAT treatment of services provided by fund managers has been introduced, which alters the taxation landscape:
- Going forward, if a fund manager in the UAE provides fund management services to a fund within the UAE (licensed by a competent authority in the UAE), these services will now be exempt from VAT.
- If the fund is outside the UAE, the zero-rated VAT will continue to apply, provided conditions are met.
To qualify for the VAT exemption, it’s important for the fund managers to assess whether the services provided fall within the exemption specified in the VAT Executive Regulations, which covers management of the fund’s operations, management of investments for or on behalf of the fund, monitoring and improvement of the fund’s performance. Further, these services should be provided to the fund which is licensed by the competent authority in the UAE. It isn’t yet clear which authority would be regarded as a competent authority, and the FTA is expected to clarify this before 15 November.
The role of management of funds is usually performed by GPs and it’s important for GPs to assess the implications. Also, in certain cases, if the GP has outsourced the management activities to an independent fund manager, then the fund manager wouldn’t be in a position to claim exemption as the fund manager would charge the GP, and not the fund, for its services.
Input VAT and Its Implications
Because the services provided to UAE-based funds are now VAT-exempt, fund managers cannot claim input VAT in full. This leads to an increase in costs as they are unable to recover VAT on their expenses, such as legal fees, audit services, and office rent.
This shift raises a question: Can fund managers pass on these increased costs to the funds through a change in the fee structure? While this may be an option, it’s worth noting that the overall cost to the fund may still reduce compared to the current VAT regime. This is because 5% VAT wouldn’t be charged on the fund manager’s services.
VAT on Services Provided from Outside the UAE
If a fund in the UAE avails itself of services from outside the UAE, no Reverse Charge Mechanism (RCM) reporting is required, which simplifies VAT compliance for funds seeking global expertise.
De-Registration and VAT Groups
For fund managers whose sole services are provided to funds in the UAE, the question arises: Should they de-register from VAT since their supplies are now exempt? This is a crucial point for managers to evaluate in light of their broader business activities.
Additionally, if the fund manager and the fund are part of a VAT group, the implications of the recent changes need to be carefully analysed to ensure that all VAT obligations are met without unnecessary cost increases.
Closing Remarks
The recent changes in VAT legislation necessitate a thorough assessment of fund structures to understand their tax obligations and overall cost implications. It may be important to consider that the FTA hasn’t specified the transitional rules to give effect to this exemption. The general position could be that, if the date of supply for a continuous supply of services falls after 15 November, the services would be exempt even though they may actually have been provided before this date. It is crucial for fund managers, fund administrators, and investors to take proactive measures to evaluate their VAT position in light of these changes, ensuring compliance while optimising costs.