There were a surprisingly large number of tax changes in the pre-election Budget and Finance Act affecting the funds industry.
The introduction of a new tax-free allowance for interest distributions and interest from next year will change the savings landscape. The Government is yet to be persuaded to remove withholding tax from interest distributions as they are doing for interest. Enabling surviving spouses/civil partners to take over the deceased’s ISA allowance turns them into a form of pension substitute. Permitting ISA investors to withdraw and replace amounts from current year ISAs later this year will obviously increase pressure on administrators’ systems.
A number of other announcements will have more limited impact, for example, the new charity authorised investment funds status will bring a VAT benefit that may persuade existing CIFs to convert.
The Government’s confirmation that it intends to introduce an SDLT regime for co-ownership ACSs and a PAIF seeding relief (subject, in both cases, to ensuring that no loopholes are opened up) is welcome, as is the refinement of the disguised investment management fees regime effectively enabling the status quo to be retained in many cases.
Some other changes, such as the diverted profits tax and the new charge to capital gains tax for non-residents holding UK residential property could, potentially, catch investment funds or their managers, but in practice we expect most entities to be able to work within their parameters.
Click below for further details about each of these changes:
- Tax on interest
- ISA changes
- Peer-to-peer lending
- Property funds and SDLT - Land and Buildings Transactions Tax (LBTT) in Scotland
- Charity authorised investment funds
- Disguised management investment fees
- Diverted profits tax (DPT)
- New charge to capital gains tax for non-residents holding UK residential property
1. Tax on interest
The Government has announced a tax-free interest allowance, which will result in no tax payable on interest received by most UK residents from 6 April 2016. The allowance will cover the first £1,000 of savings income for basic rate taxpayers and the first £500 for higher rate taxpayers. There will be no allowance for additional rate taxpayers.
Consequently, banks and building societies will no longer be obliged to deduct tax from interest paid on deposits.
One likely consequence of this will be to make cash ISAs an irrelevance for many retail investors, thus freeing up their ISA allowance for equity investment.
However, strangely, this change has not been accompanied by a corresponding removal of the obligation on authorised funds to deduct tax from interest distributions to UK resident investors, so that they must continue to do so.
It may well be that not extending gross payment to funds was an inadvertent omission by the Government. If not, it does seem perverse, especially given that everyone except UK resident individuals is already paid interest distribution gross and, if UK residents so desire, they too can receive gross distributions simply by investing in offshore bond funds instead of UK authorised funds.
It should also be remembered that bond funds are in direct competition with deposit accounts for investors’ cash. This incomplete or inconsistent change in the treatment of interest appears to introduce a tax driven distortion to the market, to the detriment of UK based funds.
Therefore, in the spirit of the UK Investment Management Strategy and to preserve the competitive position of the UK fund industry, it is to be hoped that, on consideration, the Government will realise the advantages of extending gross payments to interest distributions for authorised funds.
Such a change would help place UK funds on a fair, competitive footing with both bank deposit accounts and foreign funds. As a useful bonus, it would also create significant simplification in the administration of UK, interest-paying funds. It would also, along the way, save the many basic rate taxpayers who hold such investments from making regular tax reclaims and HMRC from having to process those reclaims.
2. ISA Changes
Whilst the list of qualifying investments for ISAs will be extended slightly , with effect from 1 July 2015, more significantly, the Government is also considering how to include in ISAs, securities offered via crowd funding platforms and peer-to-peer loans. It intends to consult on this over the summer.
The Government also proposes (from autumn 2015) to make ISAs more flexible, by permitting the replacement of money withdrawn (provided that it is replaced in the same tax year) without the replacement counting towards the annual ISA limit.
A further change that will be important to those who are married or in civil partnerships (especially where ISAs form part of their retirement planning), allows the surviving spouse or civil partner an additional one-off ISA allowance, which will allow them to invest the same amount as previously held in ISAs by a deceased partner into their own ISA. This will apply from 6 April 2015 (where the death occurred after 3 December 2014). Time limits for reinvestment are set out in draft regulations available on the Government website.
The Government is also planning to introduce a new “Help-to-Buy: ISA” which will offer a direct, if somewhat limited, incentive to first time buyers saving for a deposit by adding 25% to amounts deposited up to a maximum, direct subsidy of £3,000.
ISA managers will want to consider offering the new Help-to-Buy: ISA. Although the incentives offered are limited and aimed at a very specific class of investor for a specific purpose, once the initial objective is achieved those investors will have been introduced to tax-free saving and investing and are more likely to continue to save through the main ISA scheme. The young-adult-target investors for the Help-to-Buy: ISA may well be the significant investors of the future.
3. Peer-to-Peer Lending
As well as consulting on how peer-to-peer lending can become part of an ISA (see note on ISAs), the Government is introducing a bad-debt relief for losses on peer-to-peer lending.
The relief is proposed to apply to bad debts from 6 April 2015 and to be enacted in Finance Bill 2016 (presumably, if the next Government agrees!)
The relief is intended to allow the cost of loans which are determined to be “bad debts” (in accordance with conditions) to be offset against the lender’s income from other peer-to-peer lending before it is taxed. To the extent that any amount is paid subsequently, it will then come back into the tax charge at that time.
Draft legislation will be published later in 2015. Meanwhile, HMRC have published a brief technical note on the proposed relief which can be found here.
4. Property Funds and Stamp Duty Land Tax Rules (SDLT) - in Scotland Land and Buildings Transaction Tax (LBTT)
While new forms of fund structure to hold real estate in the UK (specifically the property authorised investment fund (PAIF) and the tax-transparent co-ownership authorised contracted scheme (CoACS)) continue to excite considerable interest and have given rise to some new fund launches, concern remains about the SDLT (and now in Scotland, the LBTT) implications of setting up new funds and transferring UK property portfolios into those funds.
When UK property is held subject to an existing unit trust then, properly structured, a 100% SDLT relief already exists for transferring UK property to a PAIF.
As from 1 April 2015, when the property is located in Scotland, LBTT and not SDLT applies to any relevant transfers. There is, however, currently no relief for transfers of property located in Scotland from a unit trust to a PAIF equivalent to that available in respect of SDLT where the property is located in the rest of the UK. Accordingly, currently, there will be a LBTT charge where a fund has some properties located in Scotland even though there is no change of economic ownership.
HM Treasury and HMRC ran a consultation on SDLT and property funds which closed in September 2014. This considered widening the relief from SDLT for PAIFs and also new rules for SDLT treatment of property held in tax-transparent funds, such as CoACS. The consultation conclusion and original documents are available here.
The Government’s intention to make changes to SDLT rules in line with the consultation conclusions was confirmed at Budget 2015, with legislation proposed to be made in Finance Bill 2016, after further consultation. The Government announcements made clear, however, that the Government will wish to ensure that the proposed changes do not give rise to avoidance opportunities, so the funds industry will need to work closely with them to achieve appropriate drafting.
There are, however, currently no similar proposals regarding LBTT for property located in Scotland. The asset management industry will, no doubt, wish to make representations to the Scottish Government with a view to appropriate changes, given the implications of this for the management of property in Scotland and for the Scottish property market.
In summary the SDLT proposed changes are:
To create a new 100% relief for the SDLT charge on acquisition of property by the PAIF when the acquisition results from the transfer of the existing property portfolio into a new PAIF (or another very similar structured specialist property investment vehicle). As currently proposed, this is relatively narrow, working for 100% group structures but not where some ownership of a ‘seeding’ portfolio is initially outside the group.
- to remove the SDLT charge on the issue, cancellation or transfer of units in an CoACS (in most circumstances), and
- to create a SDLT charge which will apply to the fund participants when property is transferred into a CoACS fund (even if there is no change of economic ownership), (the fund manager will be responsible for collection of the tax by deduction from the fund in proportion to participants’ holdings), but
- also to create 100% relief (as for PAIFS) on the transfer of property portfolios into a new CoACS which meet the relevant conditions.
The exact conditions for the proposed SDLT relief will be part of the further consultation. A key practical, indeed viability, issue here will be the operation of any clawback mechanism. This is likely to affect different commercial arrangements in varied ways. The end result will be a balancing act. In practice, the funds industry will need to be mindful, in putting forward practical approaches, of the Government’s concern about possible uses of a seeding relief for avoidance of SDLT.
The recent Scottish legislation and the guidance issued by Revenue Scotland do not contain a PAIF conversion relief similar to that available for property situated in the rest of the UK for the transfer of property from an authorised unit trust to a PAIF. It is not expected that the Scottish Government will want to place the property market in Scotland at a comparative disadvantage and so it is believed likely that they will consider enacting a similar relief in respect of LBTT to that already available for SDLT (UK Statutory Instrument 2008 No.710).
It is also possible that the Scottish Government may wish, at the same time, or shortly following, to consider whether LBTT changes similar to those envisaged by the UK Government consultation (summarised above) would also help the Scottish real estate industry.
5. Charity Authorised Funds
The Budget Red Book stated: “2.108 Charity Authorised Investment Funds – The government is working with the Financial Conduct Authority (FCA), the Charity Investors’ Group and the Charity Commission to introduce a new Charity Authorised Investment Fund structure that will bring new investment funds established for charitable purposes under FCA regulation, ensuring they receive the same regulatory oversight and protections as funds for retail investors.”
It is, therefore, expected that where a fund has objectives that the Charity Commission accept as being charitable, it will then be able to be both registered as a charity and (again providing it meets the FCA criteria) be authorised (and incorporated, if constituted as an open-ended investment company) by the FCA.
The effect of this will be to enable the fund to benefit from both charitable tax treatment, such as exemption from stamp taxes on purchase, and also from the tax treatment available to authorised funds, such as the exemption from VAT on management fees.
In order to benefit, however, a fund will need to be open only to charitable investors.
Existing charitable investment funds may then find it beneficial to seek authorisation by the FCA in order to benefit from the VAT exemption.
6. Disguised Management Investment Fees
The Government’s 2014 Autumn Statement included an announcement that rules would be introduced from 6 April 2015 to ensure that certain sums which arise to investment fund managers for their services are charged to income tax where the relevant manager has entered into an arrangement involving a partnership.
The new rules are now enacted in the Finance Act 2015 which was published on 26 March. HM Revenue and Customs (HMRC) also published a detailed technical note dated 29 March.
The rules adopt a broad brush approach, with exclusions, rather than targeting specific anti avoidance.
To read the full article, click here.
7. Diverted Profits Tax (DPT)
While initially thought to be focussed on large multinational technology/IP companies, it is quite clear now that the new 25% DPT, in force from 1 April this year, could potentially catch some funds or fund managers. In addition, it is now stated that it can also apply to property, which some had initially hoped would be outside the scope.
The tax still only catches arrangements involving trading where one of the parties is a 'large' company, which should help ensure that many fund managers and others are outside its scope.
While the rules are complex, the main heads of charge are:
- Arrangements involving a foreign trading company, which are designed to avoid a UK permanent establishment, where there is either a tax avoidance motive or insufficient economic purpose. It is quite possible these could catch some, for example, offshore management structures. The usual rules for avoiding a permanent establishment, through the independent agent route, will really only work here if that agent is not connected. Quite whether the actual profits will be taxable under the new rules will depend on the factual matrix, but some businesses may need to review their arrangements, including bringing certain activities into the UK tax net to avoid potentially paying 5% more tax than is necessary.
- Otherwise diverting profits from the UK, whether through UK or non-UK entities, where there is both an effective tax mismatch (broadly the tax paid is less than 80% than it would otherwise have been) and insufficient economic substance (arrangements that are contrived, designed to avoid tax and that lack economic substance).
In assessing whether there is an effective tax mismatch, helpfully there are certain carve outs, most notably for payments to offshore funds or authorised investment funds, which meet the genuine diversity of ownership condition or where at least 75% of the investors throughout the relevant accounting period are registered or overseas pension schemes, charities or people entitled to sovereign exemption from tax.
Transfer pricing arrangements will be taken into account, but in the second of the two charges, these can effectively be overridden if it is reasonable to assume that an alternative provision could have been made. In that case, the alternative provision could be substituted to arrive at the appropriate tax on a just and reasonable basis. It would be a nightmare position to determine what that alternative might be!
One of the main issues with the new rules is the notification and collection mechanics. Fortunately, the notification requirements have been watered down considerably following industry consultation. In particular, they now contain an exception where it is reasonable for a company, or a connected company, to conclude that it has supplied sufficient information to enable HMRC to decide whether to give a preliminary notice for that period and HMRC has examined it whether as part of a return or otherwise. Where, therefore, fund managers think that they may have arrangements that could potentially be within scope of the rules, but which should not actually be taxable, it is likely that they will wish to engage with their CRM (if they have one) on the relevant issues to side step the notification requirement and reduce the compliance burden. Ongoing monitoring to ensure no change of circumstances would still be required.
Read a fuller article on the DPT here.
8. New charge to capital gains tax for non-residents holding UK residential property
The extension of the UK CGT regime for residential property to non-UK tax residents, is now in force and is the latest in a line of several new tax rules affecting the sector. This time, there is no threshold before it clicks in, merely a disposal post 6 April this year. The new rule represents a fundamental change to the taxation of UK real estate, which previously allowed the UK to be an effective tax haven for non-UK residents seeking capital growth. Importantly, the changes only apply to interests in a dwelling (or which was a dwelling) or off plan contracts for dwellings and grants of options on them. They do not affect commercial property.
In the context of funds there are certain vital exclusions, most notably, for widely-held collective investment schemes and for non-close companies (broadly, those controlled by five or more unconnected people). We assume that for consistency with the rest of the CGT code, funds treated like companies for tax purposes (such as JPUTs and FCPs) will also be treated like companies and not collective investment schemes, though the drafting is not yet clear. Helpfully, there is an extended definition of non-close where a fund has qualifying institutional investors. This ensures that funds which are only close by reason of having, for example, insurance companies and pension funds as major investors should not be caught. Of further use also in ensuring that the charge does not apply, the tricky rules around attribution of interests in limited partnerships in determining whether a company is treated as close have been disapplied. This should enable relevant funds with a mixed investor base, but, say, a major pension fund or sovereign wealth fund as one of them, who are currently investing in the UK residential sector via a partnership investing in offshore companies not to be caught.
As a related change, cells of umbrella companies will be treated as separate companies for the close company provisions for the purpose of these rules. This will stop some planning aimed at the high-net-worth market.
Partnerships, generally, will be treated as tax transparent, so you would look at individual investors to see if the charge applied to them.
Unexpectedly, there is no exemption for charities in determining whether an offshore fund in corporate form or treated like one (like a JPUT) is close or not. It is not clear at present whether this is an oversight or not, but, in its current form, it will have implications for some structures.
We may see some investors as a result of the changes wish to structure using some of the UK structures. This may look more attractive anyway now that the Schedule 19 charge has been abolished for onshore structures and there is more choice (see also the article on Charity Authorised Funds).
Of course, the rules only apply to non-UK tax residents, so that UK based funds, such as REITs or PAIFs will not be caught.
Managers should be aware that, notwithstanding the existence of an exemption it still actually has to be claimed within 30 days after the date of disposal. Otherwise, there will be penalties for late filing.
ATED, of course, still looms large and if relevant takes precedence over the new charge.
The relief for landlords, available to those potentially within ATED, does not, however, apply here, so that some offshore landlords will definitely be caught.
For more information on the new CGT charge, click here.