Key Tax Developments for Funds and Fund Management. John Davison

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1 Key Tax Developments for Funds and Fund Management John Davison

2 Overview: Product-specific: Taxation of UK Property AIF Regime Taxation of FAIFs Taxation of UK QMMFs General AIF tax issues: Schedule 19 SDRT Trading vs. Investing/Capital vs. Income Future framework of tax for AIFs Withholding tax (gross payments regime) VAT matters for managers: case update EU review

3 UK Property AIF regime (1) UK AIF regime: 20% CT on income UK investors ideal tax rates: Basic rate 20% (investment income) Higher rate 40% Corporate 30% Exempt nil

4 UK Property AIF regime (2) (Current regime) BR HR Corp X +0% I.T. +20% I.T. +10% C.T. +0% I.T. AIF Rent 20% C.T. Real Estate

5 UK Property AIF regime (3) Total tax for investor in PAIF: Basic Rate 20% Higher Rate 40% Corporate 30% Exempt 20% - PROBLEM: should be nil

6 UK Property AIF regime (4) Possible solutions & problems: Bond fund regime: nil tax charge on overseas investors REIT regime: daily streaming of expenses impossible Corporate unit-holder rules for UK exempt investors: non-eu compliant Exemption: - no industry consensus - WHT regime would be required

7 UK Property AIF regime (5) Fund tax: Three streams Property = exempt (like REIT) FII = exempt (generally) Interest/other = taxable, with deductible distribution (like bond fund)

8 UK Property AIF regime (6) WHT: WHT regime for property + interest UK exempt + UK corporate receive GROSS UK taxpayers + non-residents receive NET

9 UK Property AIF regime (7) Other key points Corporate investor limited to 10% PAIF must be an OEIC (legally, a Co. pays a divi) This ensures a minimum level of UK tax on UK property income

10 UK Property AIF regime (8) 10% limit: 10% limit administratively difficult (changing investor base, intermediation) Use normal AUT as feeder (20% CT on income from PAIF, paying dividend with 10% tax credit) Result: correct tax rates

11 UK Property AIF regime (9) UK Corporate (30% rate): TC for 20% tax in fund + 10% further tax AUT UK Life Co (<20%?): refund of part of 20% TC? 20% PAIF Non-UK corporate: 20% tax in fund less any DTT claim (e.g. ½ of 10% tax credit) Non-UK non-corporate 20% WHT (less any DTT claim) UK HR: 20% WHT + 20% = 40% UK BR: 20% WHT UK exempt: no WHT Rent

12 UK Property AIF regime (10) Tax rates (with feeder): UK BR: 20% UK HR: 40% UK Exempt: nil UK Corporate: 30% (or less if life company) Non-UK: 20% (less DTT claim)

13 Taxation of FAIFs (1) FAIF = Fund of Alternative Investment Funds Could be a Fund of Hedge Funds. i.e. Fund of Non-Distributing Offshore Funds Problem: capital gains which are offshore income gains would be taxable (as income) rather than exempt (as capital)

14 Taxation of FAIFs (2) Solution: Elective regime (Budget Report 2008): FAIF opts to be treated as offshore income gain in hands of own investors Benefit: FAIFs own offshore income gains treated as exempt for the FAIF Avoids double layer of tax on capital items Issue: with the 18% CGT, does this look too unattractive? Alternatives? New OSF regime might give sufficient flexibility for FAIF to compute income measure (excluding capital) for some of its investments, so normal regime may be preferable Solution via tax exemption for AIFs?

15 Taxation of UK QMMFs Stable NAV QMMFs: Stable NAV: distribution net income (i.e. capital gains/losses impact on distribution) Issue: if there is a capital loss, distribution would be reduced if this were made-up out of retained income, and there would be net taxable income left in the fund (i.e. distribution < taxable income) In practice, MMF operators likely to make-up any capital loss to avoid reputational risk?

16 Schedule 19 SDRT (1) Basic charge: 0.5% on surrenders in 7 day period 2 reduction fractions, where surrenders exceed issues (in 14 day period) and where fund holds exempt assets SDRT = 0.5% x S 7 x I 14 /S 14 x N/(N + X)

17 Schedule 19 SDRT (2) Problems: SDRT = 0.5% x S 7 x I 14 /S 14 x N/(N + X) Sometimes, manager doesn t know S and I ( netting, i.e. transfers off the register, by intermediaries) N & X not always clear, e.g. CIS are not X unless pure UK bond fund (i.e. double charging for FoF, charging in respect of debt instruments) Administratively burdensome

18 Schedule 19 SDRT (3) HMT Discussion Paper options: Fixed charge based on assets held Annualised version of current charge; OR IMA view: complete abolition is the only option which allows UK AIFs to compete internationally

19 Trading vs Investing/Capital vs Income (1) Basic relationship a/cs and tax: AIF pays 20% on income AIF is exempt from CT on chargeable gains Prima facie, tax charge should equal 20% of amount of net income, and nil in respect of items on capital account So why might this not be so?

20 Trading vs Investing/Capital vs Income (2) Capital versus income: an accounting matter Derivatives: should gains be treated as income or capital - subjective? Accounting opinion becomes key Ambiguity, challenge? In case of uncertainty, may favour OSF? (but issue also arises where DF status is required & income must be computed)

21 Trading vs Investing/Capital vs Income (3) Trading vs. Investment: a tax matter What is trading? Badges of Trade (1955 Royal Commission on Taxation of Income & Gains) Case law Notoriously subjective

22 Trading vs Investing/Capital vs Income (4) Trading vs. Investment: a tax matter If trading, tax on all gains? Extremely serious consequence, even if remote HMRC s stated view helpful BUT if in doubt, opt for Offshore fund? (and issue remains for DF status)

23 Trading vs Investing/Capital vs Income (5) Solutions HMRC guidance TB60, TB80, pbr 2007 on derivatives Possible framework: CIS, available to be widely held, engaged in investment transactions (as in IME) with NAV-pricing should always be investing Anti-avoidance: should fall on a guilty investor, not the fund (and innocent investors)

24 Future framework for taxation of AIFs (1) Benefit of taxation: DTT WHT benefits Issues: Bad news in prospectus DTT benefits being eroded anyway (challenge by Treaty partners, general reduction in intra-eu WHT) OECD project on CIVs (exempt funds may gain DTT benefits anyway) Wider UK CT review on foreign profits (move to general exemption for foreign-source divis?)

25 Future framework for taxation of AIFs (2) Exempt funds regime: Can assume non-uk higher WHT costs Should presume UK WHT regime on income paid out: 20% for income from interest 20% for income from property Nil for income from UK dividends What about non-uk income (already subject to WHT): would there be additional WHT at the UK fund level?

26 Future framework for taxation of AIFs (3) Move towards a UK exempt fund regime could the UK actually become a domicile of choice for funds? Exempt UK funds regime could compete with Lux/Irish funds BUT Sch 19 SDRT currently remains UK use of Trust structures slightly unattractive internationally ( what are they? ) BUT OEICs could be sold internationally, what about a transparent Contractual Fund Lux/Ire already well-established for cross-border selling BUT UK is investment management centre IMA launched debate in September 2007, further discussions with HMT in February 2008 initial statement in Budget Report 2008 If the UK moves to general corporation tax exemption for foreign-dividends, consensus likely to form behind tax-exempt AIF regime over the next few years

27 Withholding tax (gross payments regime) (1) SI 2006/964 originally required gross payment of interest distributions from April 2007 This was deferred in Spring Unworkable as drafted: exempt and taxable investors mixed in single intermediary a/cs

28 Withholding tax (gross payments regime) (2) Solution Direct investors: gross or net as appropriate Intermediaries: choice of 1) Two accounts (gross and net) 2) Single account, gross receipt and WHT operation by the intermediaries

29 Withholding tax (gross payments regime) (3) PAIFs: Three income streams, two of which are subject to WHT (property and interest ) Similar issues for funds and intermediaries, so issue now goes beyond bond funds

30 VAT matters for managers (1): case update and EU review Recent cases may have retrospective effect for investment managers and other providers of services to funds EU review of VAT system for financial services and insurance any effect should be prospective for investment managers and other providers of services to funds

31 VAT matters for managers (2): case update Recent cases: application of VAT exemption for management of Special Investment Fund (SIF) Abbey: fund administration = management, so TPA services were VAT-exempt (if essential, specific ) JP Morgan Fleming Claverhouse: closed-ended company was capable of being SIF, i.e. investment management services provided to Investment Trust Company should be exempt Pensions: a challenge that a pension should be a SIF (i.e. VAT exemption for investment management fees) may be next?

32 VAT matters for managers (3): case update Why is this not good news for everyone (except HMRC)? S80 VATA 1994 claim must be made by taxpayer (i.e. manager) Taxpayer reclaims net VAT previously paid (i.e. output VAT charged on services to client, less input VAT previously treated as deductible but now NOT deductible) i.e. client has suffered more VAT than manager gets back!

33 VAT matters for managers (4): case update HMRC Manager pays over Y-X to HMRC Manager submits claim for Y, less X now irrecoverable ITC Client Client refund = Y - X Manager s Output VAT = Y Manager Manager s input VAT = X 22 November 2007

34 VAT matters for managers (5): case update Current status following JPMFC case: HMRC currently considering reclaim mechanics HMRC will also need to amend VATA 1994 to widen the definition of SIF going forward (to include ITCs, also some OSFs, other closed-ended such as VCTs etc) Investment managers currently computing amounts they will be refunding to ITC clients A number of pension funds are asking managers to lodge claims for exemption as yet, we await a test case (although more than one appeal has been submitted to the VAT Tribunal)

35 VAT matters for managers (6): EU review EU review: Definition of Special Investment Fund to widen? Final Commission proposal looks at investments rather than vehicles include pension funds? Definition of management to widen? Will the services of Trustees/Depositaries become exempt? Impact: possibly less VAT for funds, but increased cost of irrecoverable input VAT for managers, TPAs, Depositaries/Trustees Adequate implementation time essential to agree pricing of services

36 Questions? Product-specific: Taxation of UK Property AIF Regime Taxation of FAIFs Taxation of UK QMMFs General AIF tax issues: Schedule 19 SDRT Trading vs. Investing/Capital vs. Income Future framework of tax for AIFs Withholding tax (gross payments regime) VAT matters for managers: case update EU review

Taxing gains made by non-residents on UK immovable property

16 February 2018 NRCG Consultation HM Revenue & Customs Room 3C/04 100 Parliament Street London SW1A 2BQ Submitted via email to: NRCG.Consultation@hmrc.gsi.gov.uk RE: Taxing gains made by non-residents