Changes to the Authorised Investment Fund tax regime
26 October 2009
There have been a number of changes made recently to the taxation of authorised investment funds (AIFs) and which came into force on 1 September 2009. They are designed to make the UK a more competitive jurisdiction for these funds.
Tax Elected Funds
Probably the most significant change is the introduction of the Tax Elected Fund (TEF). This is an AIF which is designed to move the point of taxation away from the level of the fund, and instead tax the investors as though they had invested directly in the underlying assets. A similar regime has already been introduced (in 2008) in respect of Property Authorised Investment Funds (PAIFs), which must carry on a property investment business, and which moves the point of taxation to the investor.
As the name suggests, the regime is elective, and notice must be given to HMRC for the fund to enter the regime. However, the fund must meet a number of qualifying conditions, being, broadly:
- the TEF must not have a property investment business. Direct investment in property is precluded (the PAIF regime is designed to cater for this kind of business), and although investment in REITs is allowed, withholding tax will be imposed on distributions from these vehicles, making them an unattractive investment
- it must satisfy the genuine diversity of ownership test, which is designed to prevent groups of connected persons setting up one of these funds for their own benefit
- it must not be party to certain 'non-commercial' loan relationships as debtor
- the scheme documents must contain certain statements about satisfying the above conditions.
A TEF has to stream its income into two different sorts of distributions: dividend and non-dividend.
All dividend income received by the TEF must be distributed as a dividend (and with the new foreign dividend exemption, nearly all dividends will be tax free at the level of the fund), and investors will be treated as though they had received a dividend themselves. All other income is non-dividend and is treated as yearly interest paid by the TEF (and therefore the TEF should obtain a tax deduction equal to the amount of taxable income, again moving the tax point to the investor).
There are administration costs associated with this streaming, and it remains to be seen how popular these funds will be, but it is a positive step forward for the AIF regime as a whole.
Trading v Investment white list
A new 'white list' of transactions which will be regarded as capital rather than trading (and so profits will be exempt from tax, under the exemption from capital gains for AIFs) has been introduced for AIFs which satisfy the genuine diversity of ownership condition (see below).
This is designed to tackle the uncertainty over whether profits are regarded as deriving from trading transactions, rather than the more beneficial capital gains regime. The list is pretty comprehensive and include transactions in stocks and shares, options, futures, most contracts for differences, transactions in collective investments schemes, foreign currency and carbon emission products.
Note that similar rules have also been introduced in respect of offshore funds.
Genuine diversity of ownership
This condition was first introduced to apply to PAIFs, and is designed to ensure the funds to which it applies are not held by a limited group of connected persons. The test has been altered slightly since its introduction in the PAIF regime, and now the same test applies to PAIFs, TEFs and to funds which qualify for the white-list described above.
It requires that the terms and conditions of the fund must not be set in such a way as to deter a reasonable investor within the target market from investing in the fund and that it must market the fund sufficiently widely and in a manner appropriate to attract the target investors.
Funds can apply for clearance from HMRC that they meet this condition, and HMRC have published a form on the collective investment schemes section of their website to use to make this application: http://www.hmrc.gov.uk/collective/gdo.pdf.
HMRC have published draft guidance on all of the above new legislation, comments on which can be made up until 16 October 2009.
Charity pooled funds consultation
HM Treasury is also currently consulting on the possible introduction of another kind of AIF: a charity AIF. The consultation can be found here: http://www.hmrc.gov.uk/collective/gdo.pdf.
Broadly, the Government is proposing to introduce a new type of AIF for charities to replace the current system of common investment funds and common deposit funds, with the aim to move the regulation of charity funds from the Charity Commission to the FSA whilst preserving the favourable tax treatment for such funds.
Responses on the consultation can be sent to HM Treasury by 31 October 2009.
We are currently advising clients in respect of the authorisation of a tax elected fund and a property authorised investment fund, respectively. We can advise on the suitability of these funds and manage the processes of authorisation with the FSA and clearances with HMRC.