In a previous article, we reported that draft legislation had been published to extend the scope of section 363A of the Taxation (International and Other Provisions) Act 2010 to ensure that alternative investment funds (AIFs) established in a foreign country or territory could not be resident in the UK for UK tax purposes. Subject to certain minor amendments, that draft legislation was enacted following the Royal Assent of Finance Act 2014 in July and has retroactive effect from 5 December 2013.
The measure is undoubtedly a positive step for the UK fund industry. However, it needs to be applied with suitable caution. In particular, for the reasons explained below, the legislation does not give offshore funds carte blanche to hold board meetings in the UK or to appoint additional UK directors.
It is essential for the tax efficiency and success of an offshore fund that it should not be treated as UK tax resident and thus taxable on its profits in the UK. Case law has established that non-UK incorporated companies may be treated as resident in the UK if they are centrally managed and controlled from the UK. Broadly speaking, central management and control represents the highest level of control of the business of a company – this generally would be carried out by the board. However, this will only be the case where the board of the company does, in fact, exercise such control and, in the context of an investment fund established outside the UK, particular care needs to be taken regarding the role of a UK investment manager. Traditionally, the central management and control test has required offshore investment funds to have a majority of non-UK directors (and a majority of directors not connected to the UK investment manager) and to hold all board meetings outside the UK.
Section 363A was introduced in 2011, following the “management company passport” introduced by the UCITS IV Directive and in recognition that UK-based alternative investment fund managers may be required to assume additional obligations in relation to offshore funds as a result of the Alternative Investment Fund Managers Directive (AIFMD). To encourage the competitiveness of the UK fund management industry (and to permit non-UK UCITS funds to be managed from the UK without fear of UK taxation), the original form of section 363A provided that non-UK UCITS funds authorised and resident in another Member State but managed from the UK would not be treated as resident in the UK for tax purposes. Following the introduction of AIFMD, the investment management industry made successful representations to HM Revenue & Customs to seek the introduction of an extension of the section 363A residence rule to AIFs.
Amended Section 363A
Amended section 363A applies to:
- UCITS funds authorised in a foreign country or territory (note that with new section 363A, a UCITS no longer needs to be resident or subject to tax on income in such jurisdiction for tax purposes); and
- AIFs that are authorised and registered in a foreign country or territory or that have a registered office in a foreign country or territory.
However, the following are excluded from the scope of section 363A: unit trust schemes with UK resident trustees; AIFs resident in the UK by UK incorporation; investment trusts; and REITs.
The effect of section 363A is that a qualifying UCITS or AIF will never be treated as tax resident in the UK, regardless of whether its central management and control is exercised from the UK.
Pitfalls to Avoid
New section 363A will provide significant comfort and additional flexibility for many AIFs. However, it is crucial that offshore funds and their UK managers recognise certain limitations in the scope of the new legislation. By way of example:
- The legislation applies only to AIFs. It does not apply to other corporate vehicles that may form a part of a wider fund structure. For example, neither the general partner of a limited partnership fund, nor any investment SPVs used in downstream structuring, will be within the scope of the legislation. Consequently, such entities will need to comply with the traditional tests of UK residence. Where a fund structure involves both AIFs and non-AIFs, care will need to be taken to ensure that their differing tax positions are respected.
- There is a potential UK VAT issue if AIFs are treated as “belonging in the UK”. In overview, if an AIF is treated as belonging in the UK, supplies made to it will be treated for VAT purposes as made in the UK and will be subject to VAT. This could, for example, result in VAT being payable on the management fee due to the UK investment manager (with such VAT being an irrecoverable cost for the fund). Although a single board meeting in the UK would not necessarily result in an AIF being treated as belonging in the UK for VAT purposes, a pattern of meetings or other exercises of key decision making in the UK could have this consequence, depending upon the specific facts and circumstances.
- The fact that an AIF may no longer be treated as UK tax resident does not itself ensure that the fund will be free of UK tax. If an AIF with a UK investment manager is at risk of carrying on a trading activity, it remains necessary for the AIF and the investment manager to satisfy the requirements of the investment management exemption.
For non-AIF offshore companies, best practice to prevent UK residence remains compliance with the traditional offshore fund central management and control approach. In practice, and among other things, this means no board meetings should ever be held in the UK and no directors should ever participate in board meetings by telephone from the UK.
For AIFs, it is still reasonable and prudent to follow the approach summarised above for non-AIFs. This should ensure that no UK VAT risk can arise for the fund and should enable the AIF and non-AIF corporate entities within a fund structure to be operated on a consistent basis. However, new section 363A does offer a limited amount of flexibility for AIFs, which may mean (subject to the precise fact pattern) that an occasional board meeting in the UK or telephoning in to a specific meeting from the UK may be acceptable, provided that a majority of meetings in any single year are held outside the UK in another specific jurisdiction and without UK participation. However, it would be prudent for AIFs to take advice regarding the VAT risks where the fact pattern includes any element of doubt.