The Association of Real Estate Funds John Buckeridge HM Revenue & Customs Collective Investment Schemes 100 Parliament Street London SW1A 2BQ Email: john.buckeridge@hmrc.gsi.gov.uk 20 June 2011 Dear John Property Authorised Investment Funds ( PAIFs ) The Association of Real Estate Funds ( AREF ) represents the unlisted real estate funds industry and has 72 member investment funds with a collective net asset value of over 30 billion under management on behalf of their investors. The Association is committed to promoting transparency, consistency and comparability between funds and maintains a Code of Practice defining the industry standards that the Association expects its members to uphold. AREF warmly welcomed the introduction of the PAIF regime in 2008 as it effectively eliminates the tax leakage that UK authorised property funds otherwise suffer and represents a huge step forward for the industry. However, as you are aware, only a small number of property funds have elected to be PAIFs, as there are a number of issues that serve as a barrier to the widespread utilisation of the regime. Therefore, AREF has formed a working group with the aim of resolving the remaining issues preventing the real estate funds industry from achieving widespread adoption of the PAIF regime, with the principal initial focus being on existing authorised property funds. Please see Appendix 1 for a list of the member funds of AREF s PAIFs working group. There is a potential tax issue with CGT roll-over relief under section 136 TCGA 1992 wherever an existing authorised property fund with taxable investors which are to invest through a feeder fund is reconstructed. Looking first at conversions of authorised property unit trusts ( APUTs ), these will generally consist of the merger of the APUT with a newlyformed OEIC, and all the APUT s property (save a liquidation fund) will be transferred to the OEIC with shares issued to unitholders in exchange. This transfer of all the original investors is required in order to qualify for SDLT relief. It would immediately be followed by a further exchange of shares by certain shareholders for units in a newly-formed authorised unit trust feeder fund ( AUT feeder fund ). This second step is required to remove substantial corporate investors and anyone else who cannot invest directly in the PAIF from the OEIC s share register so that it can elect to be a PAIF. Secondly, where an existing property OEIC (these are less common than APUTs for historic reasons) intends to elect to be a PAIF, some of its shareholders will similarly need to switch into a newly-formed AUT feeder fund beforehand, receiving units in exchange for their Page 1 of 12
shares. We consider that both the exchanges mentioned can technically fall within section 136 TCGA 1992, as explained in Appendix 3. The main operational barrier preventing the conversion of existing authorised property funds to PAIFs is that many platform providers are currently unable to fulfil the requirement to stream distributions, which would be required to enable PAIFs to be supported on their platforms. Therefore, an interim solution has been discussed among the major retail property fund managers, which would enable fund managers to convert existing authorised property funds to PAIFs pending platform providers being able to support streaming. This proposal is outlined in more detail in Appendix 2 but, broadly, it would require fund managers to put investors who invest via a platform into their PAIF s AUT feeder fund, together with existing substantial corporate investors. This interim solution would allow conversions and launches to take place without having to wait for the platforms to modernise. In order for tax-exempt investors to benefit from the tax-efficiency of the PAIF, they need to be invested directly in the PAIF and therefore these investors who invest via platforms would be switched from the AUT feeder fund to the PAIF at a future date, once platforms are able to support streaming. And for administrative reasons, it will also generally be preferable for retail investors to invest direct into the PAIF. Switching them between the AUT feeder fund and the PAIF obviously has potential CGT implications for tax-paying investors, and there are potential SDRT implications for all switched investors. In order to encourage the conversion of existing authorised property funds into PAIFs and, generally, for the proposed interim solution to be used, we ask for public confirmation from HMRC that: reconstructions proposed by the managers of APUTs to convert them into PAIFs constitute schemes of reconstruction that qualify for roll-over relief under section 136 TCGA 1992 and no stamp tax will arise; schemes put forward by the authorised corporate director of a PAIF to switch investors from an AUT feeder fund to a PAIF, or vice versa, and structured along the lines set out in the appendices also constitute schemes of reconstruction that qualify for roll-over relief under section 136 TCGA 1992; and there will be no SDRT charge under schedule 19 FA 1999 as a result of investors being switched from the AUT feeder fund to the PAIF, or investors being switched from the PAIF to the AUT feeder fund. We have set out in Appendices 3 and 4 to this letter the technical arguments as to why we believe that this should be the case. Please do not hesitate to contact Lauren Jackson (on 020 7269 4677 or at ljackson@aref.org.uk) if you have any questions on this or would like to discuss. Yours sincerely John Cartwright Chief Executive Page 2 of 12
Cc: Wayne Strangwood, HMRC Jon Sherman, HMT Cathy Lynch, HMT Stuart Gregory, HMT Page 3 of 12
Appendix 1: Members of the PAIF Working Group The members of the PAIF Working Group represent the following funds: Aviva Investors Property Investment Fund Aviva Investors Property Trust Legal and General UK Property Trust Henderson UK Property Trust SWIP Property Trust Ignis UK Property Fund Skandia Property Fund M&G Property Portfolio LV= UK Property Fund Royal London Property Fund Threadneedle UK Property Trust Page 4 of 12
Appendix 2: Summary of conversions and interim solution for existing authorised property funds The trustee of APUTs will generally become the depositary of the OEIC and trustee of the AUT feeder fund, and this letter assumes that this will be the case. Unauthorised funds will first need to become authorised but can then follow a similar process. Background: Conversion of APUT to PAIF The APUT conversion is a scheme of arrangement and will require FSA approval and unitholder approval at an EGM. The scheme should seek FSA approval for subsequent transfers under Future changes below. Clearance in respect of CGT roll-over relief would also be obtained from HMRC. 1. Establish OEIC; 2. Establish AUT feeder fund; 3. Reclassify APUT units into classes containing unconstrained 1 APUT investors and constrained 2 APUT investors; 4. Immediately before the effective date, end accounting period and allocate income; 5. On the effective date: 6. Wind up APUT. a. transfer APUT capital property (except for the liquidation fund) to OEIC; b. transfer unconstrained and constrained APUT investors to OEIC (exchange of APUT units for issue of shares to all investors); 3 c. cancel shares of investors in constrained investor class(es); d. OEIC issues shares to AUT feeder fund; e. AUT feeder fund issues units to constrained investors in respect of d; f. election for OEIC to enter PAIF regime comes into effect (intention to elect must have been notified 42 days before OEIC incorporation); Background: Change of property OEIC to PAIF The change of status to become a PAIF will require FSA approval and either shareholder approval at an EGM or notification to shareholders. The scheme should seek FSA approval for subsequent transfers under Future changes below. Clearance in respect of CGT rollover relief would be obtained from HMRC. 1. Establish AUT feeder fund; 2. Reclassify OEIC shares into classes containing unconstrained OEIC investors and constrained OEIC investors; 3. Immediately before the effective date, end accounting period and allocate income; 4. On the effective date: a. cancel shares of investors in constrained investor class(es); 1 2 3 Unconstrained investors are those able to hold PAIF shares. Constrained investors are corporate investors (in some cases, these may be limited to those with substantial holdings) and also others including those that are on a platform that has not developed functionality to support PAIFs. This is necessary to qualify for SDLT relief. Page 5 of 12
b. OEIC issues shares to AUT feeder fund; c. AUT feeder fund issues units to constrained investors in respect of b; and d. election for OEIC to enter PAIF regime comes into effect (intention to elect must have been notified 28 days before). Background: Operations in respect of constrained investors 1. Investors buy/sell units in AUT feeder fund; 2. ACD replicates AUT feeder fund issues and cancellations in PAIF; 3. PAIF pays distributions to the feeder fund, and reports streaming information (possibly requiring manual intervention); 4. AUT feeder fund pays dividend distributions to investors (to investors this will appear no different to the pre-conversion arrangements). Consolidation issues need to be considered for financial statements. Future changes AREF will seek the opinion of the FSA as to whether this step can be taken under the authority of the original scheme of arrangement. The manager of the AUT feeder fund switches all relevant constrained investors from the AUT feeder fund to the PAIF when the platform through which they are being held becomes capable of streaming PAIF distributions (this would constitute an in specie redemption in the AUT feeder fund, and may be timed for the end of a distribution period). Page 6 of 12
Appendix 3: Capital Gains Tax Analysis: Conversion of APUT to PAIF issues arising specific to constrained investors We consider that section 136 TCGA 1992 will apply to reconstructions of APUTs where the manager proposes a two-stage scheme of reconstruction as described above. Section 136 TCGA 1992 applies where certain conditions are satisfied. The relevant ones are: (a) (b) an arrangement between a company ( company A ) and the persons holding any class of [its] shares... is entered into for the purposes of, or in connection with, a scheme of reconstruction (section 136(1)(a)); and under the arrangement... another company ( company B ) issues shares... to those persons in respect of and in proportion to (or as nearly as may be in proportion to) their relevant holdings in company A. and the shares in... company A comprised in relevant holdings are... extinguished (section 136 (1)(b)). Under the proposals, the manager of the APUT would put forward a scheme of arrangement to unitholders under which, first, each existing class of units would be divided into pairs of classes, one for the unconstrained investors and the other for the constrained investors 4 ( the first stage ). Shares in the OEIC of equivalent value (less amounts for the liquidation fund and any costs) would be issued to investors in each class on the effective date of the scheme and the APUT units would be extinguished. This satisfies the conditions of section 136 TCGA 1992 as quoted above, provided that the scheme constitutes a scheme of reconstruction as described in Schedule 5AA TCGA 1992. In order for a scheme to constitute a scheme of reconstruction for the purposes of Schedule 5AA TCGA 1992, it must satisfy the first and second conditions in that Schedule and either the third or fourth ones too. The first condition (issue of ordinary share capital) and the second condition (equal entitlement to new shares) will necessarily be satisfied since the PAIF is an FSA-authorised investment fund bound by the relevant part of the FSA s handbook, COLL. It is then necessary for the scheme to satisfy the third condition, dealing with the continuity of business, because the fourth condition (compromise or arrangement with members) cannot apply. There is one original company for the purposes of the condition. Consequently, to fall within the third condition, the effect of the restructuring must be that the business or substantially the whole of the business carried on by the company is carried on. by two or more successor companies (which may include the original company) (paragraph 4(1)(a)(ii)). It is HMRC s published position 5 (and it has long been Revenue practice) that the transfer of a portfolio that was commercially managed from one investment company or fund to another investment company or fund which also has commercial investment management arrangements in place constitutes the transfer of a business for the purposes of paragraph 4. Paragraph 4(a)(ii) is therefore satisfied because the business of the original company is carried on by a successor company. 4 5 While reclassification of the units may not technically be necessary at this stage, it may in practice be useful to minimise later administrative steps. Capital Gains Manual at paragraph 52726. Page 7 of 12
In summary, the first stage of the reconstruction is a classic authorised investment fund merger and investors will qualify for section 136 roll-over relief in the normal way. The second stage consists of a reconstruction of those share classes in the OEIC held by the constrained investors into matching unit classes in one or more AUT feeder funds (which may be sub-funds of an umbrella fund). In this stage, units of the appropriate class and of equivalent value (there are unlikely to be any costs) in the feeder fund or funds would be issued to each class of constrained shareholder on the effective date of the scheme and their shares would be cancelled. The conditions of section 136 roll-over relief therefore appear to be satisfied, provided that the reconstruction constitutes a scheme of reconstruction for the purposes of Schedule 5AA TCGA 1992. Looking again at Schedule 5AA, the first and second conditions (issue of ordinary share capital and equal entitlement to new units) will necessarily be satisfied because of the FSA s requirements. The tension arises with the third condition. As with the first stage, there is one original company, the OEIC, and to qualify for section 136 roll-over relief the effect of the restructuring must be that the business or substantially the whole of the business carried on by the company is carried on. by two or more successor companies (which may include the original company) (paragraph 4(1)(a)(ii)). As noted above, the transfer of a managed portfolio between investment funds constitutes the transfer of a business for the purposes of paragraph 4. Similarly, HMRC practice is to accept that when such a portfolio is transferred it may first have been realised and be transferred in the form of cash to be reinvested in the successor company/ies, whether this is necessary for regulatory reasons or is done for commercial reasons. Paragraph 4(a)(ii) is therefore in our view satisfied because the business of the original company (ie the AUT feeder fund) is carried on by two. successor companies (which. include[s] the original company), since both the OEIC and the AUT feeder fund will be carrying on investment businesses as a result of the reconstruction. It would alternatively be possible to argue that the constrained classes roll-over from the APUT (through the OEIC) into the AUT feeder fund, but the disadvantage of this argument is that it would not apply to existing property OEICs. This may preclude existing property OEICs with substantial corporate investors from electing for PAIF status since their corporate investors are typically life offices, again typically with some taxable business, and they would be bound to vote against any change that disadvantaged them. We appreciate that this is not the usual fact pattern for paragraph 4, but this transaction is a direct result of the statutory requirements for SDLT relief and the master-feeder structure of the PAIF and AUT feeder fund. (We appreciate that master-feeder transactions may also arise in future with UCITS IV). We do not, however, consider that this interpretation opens up the possibility of widespread claims for CGT roll-over relief on investor switches, because for section 136 roll-over relief to apply there must be a scheme. Rather the position would be analogous to investors switching between funds in a fund manager s range, where CGT is clearly in point, in contrast to a merger being proposed by the manager, where section 136 roll-over relief will apply. The alternative analysis is obviously that section 136 roll-over relief is not available because the third condition of Schedule 5AA is not satisfied because the business acquired by the AUT feeder fund is not part of the existing business of the APUT or OEIC. This analysis would generally in practice prevent existing APUTs with constrained investors from converting to PAIF status, as the proposal would be voted down. Page 8 of 12
Analysis: Change of property OEIC to PAIF issues arising specific to constrained investors The position here is exactly the same as stage 2 of the APUT conversion described above, save that the double roll-over possibility is not available. Analysis: Operations in respect of constrained investors We consider that section 136 TCGA 1992 will also apply where a manager of an AUT feeder fund puts forward a scheme to investors in it to switch their holdings in the AUT feeder fund for shares in its underlying PAIF, as described below. Section 136 applies as stated above where certain conditions are satisfied. Under the proposals, the manager of the AUT feeder fund would put forward a scheme 6 to unitholders under which the units of each class of holders (if there is more than one) elect to switch into the PAIF and would each be reclassified into a separate class (ie there would be mirror classes). Shares of equivalent value (there are unlikely to be any costs for investors) in the PAIF would be issued to each class of unitholder on the effective date of the scheme and their units would be extinguished. The conditions for section 136 roll-over relief would therefore be satisfied provided that the proposed scheme constitutes a scheme of reconstruction. Working through the definition of scheme of reconstruction in Schedule 5AA TCGA 1992, the first condition (issue of ordinary share capital) and the second condition (equal entitlement to new shares) will necessarily be satisfied since the PAIF is an FSA-authorised investment fund bound by COLL. To fall within the third condition, the effect of the restructuring must be that the business or substantially the whole of the business carried on by the company is carried on. by two or more successor companies (which may include the original company) (paragraph 4(1)(a)(ii)). As stated above, HMRC practice is to accept that a managed portfolio may be transferred in cash form and reinvested in the successor company/ies. Paragraph 4(a)(ii) is therefore in our view satisfied because the business of the original company (ie the AUT feeder fund) is carried on by two. successor companies (which. include[s] the original company). To summarise, in our view, the proposals constitute a scheme of reconstruction as defined in Schedule 5AA TCGA 1992 and satisfy the other conditions in section 136(1) TCGA 1992. Unitholders switching their units under a manager-led proposal where the units are reclassified would therefore do so on a mandatory no gain/no loss basis as the proposals qualify for treatment as share reorganisations under sections 127-131 TCGA 1992. The alternative interpretation of reconstruction would obviously be that such transactions are not reconstructions and do not attract roll-over relief where the manager switches holders from the AUT feeder fund to the PAIF. 6 This could either be part of the conversion scheme of arrangement or a standalone scheme proposed by the AUT feeder fund manager. Page 9 of 12
Appendix 4: Stamp Duty Reserve Tax Analysis: Conversion of APUT to PAIF It is necessary to consider the transaction at both the asset level in respect of SDLT (and probably SDRT on some UK property equities under section 87 FA 1986) and the unit level in respect of SDRT under Schedule 19 FA 1999. Transfer of the APUT s scheme property to the new OEIC in exchange for the issue of shares In order for a conversion to be viable, the parties must ensure that the land transactions transferring properties from the authorised unit trust scheme to the OEIC will satisfy the conditions set out in Regulation 3 of the Stamp Duty Land Tax (Open-ended Investment Companies) Regulations 2008 (SI 2008/710). Reviewing the conditions set out in Regulation 3(2): the whole of the available property of the target trust will become the whole of the property of the acquiring company as part of the scheme of arrangement to convert the authorised unit trust to an OEIC; all the units in the authorised unit trust scheme will be extinguished; the consideration will comprise only shares in the new OEIC; the new shares will be issued to the former unitholders in appropriate proportions; and there will be no other consideration. Accordingly, provided the transaction takes place as proposed, we consider that the land transactions constituted by the transfers of the various UK properties from the authorised unit to the OEIC will be exempt from SDLT. The cancellation of the units in the authorised unit trust and the issue of shares in the OEIC, fall squarely within the fact pattern set out in the paragraph headed SDRT: Schedule 19 Finance Act 1999 in the Stamp Taxes Customer Newsletter SDRT issue No. 7 as all the units will be extinguished and the beneficial interests in all the shares issued will be issued to the former unitholders in appropriate proportions. Transfer of beneficial interests in new shares by constrained shareholders into new AUT feeder fund The simultaneous transfer by the corporate shareholders of the beneficial interests in their shares into the new authorised unit trust feeder fund in exchange for the issue of units to them will not give rise to a change of beneficial ownership because all of the transfers will be of shares in the same OEIC and will take place at the same time. For this reason, the issue of units to the corporate investors will similarly not be an issue of shares for the purposes of Schedule 19 FA 1999. Analysis: Change of property OEIC to PAIF The position is as described in the preceding paragraph except that the OEIC will not be new. Analysis: Operations in respect of constrained investors The final stage in appendix 2 (transferring investors from the AUT feeder fund to the PAIF) will be split for practical purposes into three parts: Page 10 of 12
(i) (ii) (iii) The unitholders redeem units in the AUT feeder fund and the manager cancels those units; The AUT feeder fund redeems shares in the PAIF; and The PAIF reissues shares to the former unitholder. We appreciate that what is required in theory is a simple transfer of PAIF shares from the AUT feeder fund to the former unitholder, but in practice this transaction is done through a redemption and reissue; no PAIF shares will be created or cancelled, however. An SDRT charge arises under Schedule 19 FA 1999 on surrenders of units/shares in unit trusts/oeics. Part (i) is a surrender of units in the AUT feeder fund and part (ii) is a surrender of shares in the PAIF. However, no SDRT charge should arise as a result of either surrender for the reasons set out below. Part (i) surrender of units in AUT feeder fund by unitholder for shares in the PAIF The surrender of units in the AUT feeder fund by a unitholder for shares in the PAIF would be a pro rata in specie redemption and therefore specifically excluded from the Schedule 19 SDRT charge, per paragraph 7 of Schedule 19 FA 1999. (The surrender would also be without consideration since the unitholders are the beneficial owners of the AUT feeder fund s assets 7, but this is not material in part (i) but only for parts (ii) and (iii).) HMRC s guidance on the stamp duty reserve tax regime for unit trusts and open-ended investment companies (http://www.hmrc.gov.uk/so/autif.pdf) states, at paragraph 45, that the test for an in specie redemption to qualify for the pro rata exemption is that the unit holder must get a share of each asset that is proportionate to, or as nearly as practicable proportionate to, the unit holder s share. In this case the only asset held by the AUT feeder fund will be shares in the PAIF, so on transfer from the AUT feeder fund to the PAIF, the unitholder would surrender units in the AUT feeder fund in return for shares in the PAIF that are necessarily proportionate to their units in the AUT feeder fund. Therefore, the in specie redemption should qualify for the pro rata exemption from SDRT. The AUT feeder fund may also hold cash for liquidity purposes; this is permitted by the FSA in COLL 5.6.7 (6A). The HMRC guidance referred to above, states that the exemption is an all or nothing test in the sense that the whole value of the surrender is chargeable unless the condition is met. In these circumstances, provided that, in addition to shares in the PAIF, the unitholders in the AUT feeder fund also receive an amount of cash that is proportionate to their units, this would also be a pro rata in specie redemption and therefore excluded from the SDRT Schedule 19 charge. Parts (ii) and (iii) surrender of shares in the PAIF by the AUT feeder fund and reissue The surrender of shares in the PAIF by the AUT feeder fund would be followed by the PAIF reissuing shares to the former unitholders. Together these Parts amount to a transfer of shares. The transfer would require the shares to be reregistered from the name of the AUT feeder fund trustee to the name of the shareholder (or his nominee). There would be no consideration as explained in Part (i) above. HMRC practice is to treat such transfers as surrenders and new issues for the purposes of Schedule 19 FA 1999 (HMRC stamp tax manual 15.49). On this basis, the change of ownership would fall within paragraph 6(1) of Schedule 19 FA 1999. There would be no consideration in money or money s worth in 7 M & G Securities Ltd v Inland Revenue Commissioners; Schroder Unit Trusts Ltd v Inland Revenue Commissioners (1999 STC 315). Page 11 of 12
connection with the surrender of the shares or the former unitholder becoming entitled to them. Accordingly, there would be no SDRT charge in accordance with paragraph 6(2) of Schedule 19 FA 1999. Page 12 of 12