The majority of the developments represent a package of tax measures designed to enhance the competitiveness of the UK asset management sector.
Offshore funds legislation
The offshore funds legislation is being revamped in the 2008 Finance Bill. The measure will have effect on a date to be appointed by Treasury Order. This proposal had been put forward for consultation, and the following changes are expected:
1. The concept of distributing funds is to be replaced by one of reporting funds which will have a free choice on whether or not to distribute, as long as they report 100% of their income to HMRC, allowing UK taxpayers to include it in their tax returns as it arises.
2. From the consultation document, it is expected that offshore funds would be those which choose not to report, and the regime for these would remain as it is.
3. From the consultation document, it is also expected that the legislation will contain a more flexible regime that would apply to fund of funds structures. At present, qualifying offshore funds are only authorised to invest in other qualifying offshore funds. Any investment in non-qualifying offshore funds is restricted to 5% by value of the assets of the head fund. Even then, the investment in qualifying funds is effectively restricted to one layer i.e. the sub-funds are themselves definitely restricted to a 5% holding in all other offshore funds, whether qualifying or not. It is proposed to remove these restrictions, so that reporting funds may invest in as many funds, reporting or non-reporting, as it wishes, and in as many layers as it wishes, subject to reporting rules to make sure that the income arising at all levels is reported on its share by the head fund.
The definition of what constitutes an offshore fund will not change in the 2008 Finance Bill, but the Government intends to continue its discussions with the industry on the definition and will legislate for a revised definition in the 2009 Finance Bill.
Property Authorised Investment Funds
On the market at the moment as vehicles for property investment are Real Estate Investment Trusts (REITS) and, for non-retail investors, property investment Limited Liability Partnerships, both providing tax transparency.
Authorised Investment Funds are the most popular form of retail and institutional investment vehicle in the UK and are also used for investment in property. However, the tax rules applying to them are less attractive, in particular with reference to tax leakage on income in the fund.
The new rules are introduced to make them more competitive by making them tax transparent, and indeed to provide a medium to invest in a selection of REITs.
Open Ended Investment Companies (OEICs) investing mainly in property and certain related securities will be able to elect to be subject to the new regime, which will take effect from 6 April 2008.
The effect will be that, instead of tax arising on income received by the fund, it will be deducting tax from its distributions to investors, thus avoiding the tax leakage that normally arises when investors redeem their participations during a distribution period.
The distributions will be streamed so that UK dividends which are not taxable when received by the OEIC will be passed on as dividends.
In order to qualify for this special tax treatment, an OEIC would have to meet a number of very specific conditions regarding diversity of ownership and the level of investments which a corporate could hold. The main conditions are as follows:-
1. It must carry on a property investment business (amounting to at least 60% of the business).
2. There must be genuine diversity of ownership at investor level, so that its ownership is not limited to a few investors.
3. There are limits on the holdings of corporate investors and on the type of loan financing in the fund.
This is generally a welcome addition to the collection of investment vehicles available, and makes the property market accessible to a wider base of investors.
Fund managers will be considering which of their existing funds are suitable for conversion, and these will form part of the choice of investment vehicles for UK and institutional investors (including pension schemes and insurance companies) looking for exposure in property.
Funds of Alternative Investment Funds
New regulations will be laid to remove tax as a barrier to the introduction by the Financial Services Authority of its new regulatory regime for Authorised Investment Funds to be Funds of Alternative Investment Funds (FAIFs).
These funds invest in funds which are “non-qualifying offshore funds” and the existing rules could as a consequence result in double taxation because gains realised on those funds would be taxed as income of the fund, while the investors in the funds would be taxed on gains realised on disposal of their participations.
The new rules will allow an election to be made so by those funds to be treated as “Tax FAIFs” so that they would not be subject to tax on realisation of gains on the underlying funds but the trade off would be that the investors would be chargeable on disposal of the participations as if they were themselves non-qualifying income funds, i.e. at their marginal income tax rate and, if they are companies, without indexation.
The new rules will come into force at the same time as the FSA regulatory changes will become effective.
Reform of the rules on Qualified Investor Schemes
The Government will consider revising the current anti-avoidance rules applicable to Authorised Investment Funds which are Qualified Investor Schemes (QIS), being funds which may be sold to more sophisticated High Net Worth Individuals and Institutional Investors (“qualified investors”), and which are subject to lighter regulation than retail Authorised Investment Funds.
At present, “substantial QIS holdings” are rights to 10% or more of the net asset value of a fund held by qualified investors, with exceptions for life insurance companies, pension schemes charities and those holding the participations as part of a trade.
The holder of a substantial QIS holding, instead of being subject to the normal tax rules for Authorised Investment Fund holders, is subject to tax in value fluctuations of the investment between two measuring dates whatever the underlying investments, and this is proving to be a barrier to the commercial development of those schemes.
Further developments are to be expected on the subject.
Investment Manager Exemption
The Government is introducing new rules in the 2008 Finance Bill to modernise the Investment Manager Exemption to ensure that the use by a non-UK resident of the services of an independent UK investment manager will not expose the investment returns achieved to UK tax. The new measures being introduced are:
a. a publicly available list of transactions that will qualify as investment transactions, which will be updated by HMRC for new products as appropriate; and
b. the removal of the “cliff-edge” provision whereby if any of the investment management exemption conditions are not met in respect of a transaction conducted by an investment manager on behalf of a non-resident client, all the returns on transactions conducted by the investment manager in respect of that client would be subject to tax even if only certain transactions breached a condition. This means that broadly only the returns generated by the non-exempt transactions will be subject to UK tax, while the exempt transactions will remain exempt.
Timing of income tax payments by unauthorised unit trusts
Under current tax legislation inadvertently brought about in the conception of the Income Tax Act 2007, unauthorised unit trusts are now only required to pay HMRC the income tax that they deduct from their unitholders in any fiscal year at the end of the January following the end of that tax year, in the same way as for individual investors.
This is to be changed, with effect from the tax year 2008-2009, so that payments on account will have to be made by the trustees on 31 January and 31 July of one year, with a balancing payment or claim made on 31 January the following year.
This means that for the year 2008/09, tax will be due not by 31 January 2010 but on account on 31 January 2009 and 31 January 2010 respectively, with the balancing payment or reclaim made on 31 January 2010.
Stamp Duty on sukuk
The Government is introducing new legislation in recognition of the fact that alternative finance investment bonds replicate loan capital and therefore should benefit from the same stamp duty exemptions where appropriate. The new rules will put those bonds on a par with equivalent debt securities.
These changes will have effect for transfers of loan capital on or after the date that the Finance Bill receives Royal Asset and represent a further step forward in the integration of Islamic Finance as an essential tool of the modern investment management industry.
Reform of the Schedule 19 Stamp Duty Reserve Tax for UK Unit Trusts and Open Ended Investment Companies
UK unit trusts and open ended investment companies are subject to a special SDRT charge which applies to matched transactions over a rolling two week period, with exemptions for overseas and fixed interest investments.
The current regime undermines the competitiveness of UK investment funds in the global market compared to Dublin and Luxembourg.
Apart from being complex to administer, it may in some cases result in the payment of unnecessary amounts of SDRT compared to what would have been paid on the market and is particularly unattractive for certain fund of funds structures.
In general, the best measure for promoting the UK fund industry is abolition of the current SDRT regime, which in many cases captures more SDRT than would have been payable on the open market.
HMRC had consulted with the industry with a proposal either to:
1. change the regime from a transaction to an asset based tax, based on the value of relevant assets averaged daily over the year, at a flat percentage rate of possibly 0.05%: or
2. reform the existing rules with a view to simplifying them so that there is a tax charge of on all surrenders at a rate estimated at 0.155% to maintain revenue neutrality, and with exemptions for units in other collective investment schemes.
The proposals were aiming for a tax neutral way to reduce the complexity and administrative burden.
This particular consultation is now closed, but no decision has been taken for this Budget. Instead, in view of the complexity of the issue, the Government has announced that it will continue discussions with the investment management industry with a view to determining the best options for reform.
Further reviews and consultations
Further discussions are to take place with the industry with a view to making Authorised Investment Funds transparent for direct tax purposes, and to review the rules on Investment Trust Companies in general.
