Undertakings for collective investment in transferable securities - Mazars - United Kingdom

The UCITS IV Directive, which will be transposed into UK legislation on 1 July 2011, presents attractive opportunities for the UK fund management industry.

HMRC is introducing the following measures to ensure that UK tax will not be an obstacle for fund managers taking full advantages of the following opportunities created by the Directive:-

The management company passport

Under UCITS IV, all Member States must allow UCITS established in their territory to be managed by a firm established in another Member State, either via a local branch (which the UK already allows) or cross-border on a services basis, which will be a new flexibility for UK Authorised Investment Funds.

A fund manager established in one Member State will now be able to remotely manage UCITS in several Member States from a single office, achieving considerable economies of scale. For instance, a UK headquartered fund management group will be able to directly manage a Luxembourg SICAV, a French Fond Commun de Placement, and an Irish VCC or unit trust all from its London office.

Those UCITS management companies will be subject throughout the EU to harmonised requirements for the organisational, conduct of business and risk management processes.

Whilst they will able to mandate the management of the fund portfolios and indeed the back office administration of the fund to other providers, they must retain primary responsibility for ensuring the efficient management of the fund.

Although the policy is coherent, care is required that the activity carried out in the UK does not result in a blur of boundaries to the extent that it would import the tax residence of an overseas non-tax transparent UCITS into the UK because its management company is established here.

Legislation will be introduced in the Finance Bill 2011 to provide more certainty for fund managers in this respect.

Master-feeder structures

UCITS IV allows the establishment of Master-Feeder structures whereby one UCITS (the “feeder”) holds at least 85% of its assets in another UCITS (the “master”).

A Master can be open to the market at large, or it can be open only to feeder funds, in which case it must have at least two feeders investing in it.

Fund managers can therefore distribute an investment management technique across different EU territories using locally appropriate legal structures feeding into a single pool of assets, and achieving economies of scale.

A Master and its feeder(s) do not have to be managed by the same company, and therefore a portfolio management firm selling UCITS suitable investment strategies but without the infrastructure to deal with UCITS investors on a day to day basis can form a Master fund and enter agreements with third parties of fund platforms with fund administration expertise who provide the feeders, which are then made available to the UCITS market.

There are risks. For instance a fund which is actively managed with a frequent portfolio turnaround takes synthetic derivative positions or invests in money markets and sold as a Master-Feeder structure could lose certainty of the white list of transactions classified as non-trading. This is because to qualify for the white list, UK and equivalent offshore funds must meet the “genuine diversity of ownership” condition, which means that the fund must be widely marketed with its participations available for investment to its intended category of investor and not be restricted to a specific group of persons.

If, therefore, as permitted by UCITS IV, a fund manager establishes a Master Fund to be distributed exclusively via a group of feeders established in different Member States, it would be restricting the Master Fund to a specific group of persons (the feeders) and would be depriving the master fund of access to the “white list”.

Even where a master fund is, in principle, open to other investors than the feeder, if, in practice, it is not actively marketed to them or the fund literature deters reasonable investors from investing directly instead of via a feeder, it may still fail the test and fall back within the pre-white list uncertainty.

The government has therefore agreed to modify the genuine diversity of ownership condition to accommodate the UCITS IV environment so that a “captive master” may meet it via the promotion of its feeders.

New legislation will be introduced to this effect via secondary legislation both in respect of offshore funds being promoted into the UK and seeking reporting fund status and in respect of UK Authorised Investment Funds which are subject to corporation tax in the UK on their income profits.

Draft legislation is already published in respect of offshore funds, to come in force at the end of May, and it is understood that the legislation applicable to UK funds will be in line with that draft legislation.

Looking at the draft legislation, and assuming it will apply to UK funds on the same terms, its benefits appear to extend beyond UCITS funds and the white list, which is good news:-

1. The structure does not have to be a UCITS IV structure, or even a UCITS at all, as long as the feeder funds are either UK Authorised Investment Funds or “equivalent” offshore funds, which are now extended to include funds constituted in the EEA, leveraged at 200% maximum and authorised by the competent authority in that state to market to retail or professional investors. This means that more funds will be applying for reporting fund status in the UK.
2. In the UK, the genuine diversity of ownership condition is relevant not only to the white list, but to Qualified Investor Schemes being taxable as Authorised Investment Funds instead of ordinary companies, and Tax-Elected Fund status.

On the other hand, given the versatility of the UCITS IV Master-Feeder structure and other potential master-feeder arrangements, it appears more restrictive than we would have hoped as it requires the fund and its feeder to have the same manager. We hope that HMRC will be prepared to consider further extending the scope of the amendments.

For more information please contact:

Carine Beidas

Senior Manager, Financial Services Tax