Following concerns that the conditions for approval as an investment trust company ("ITC") under section 842 of the Income and Corporation Taxes Act 1988 ("section 842") (rewritten in section 1159 of the Corporation Tax Act 2010 with effect from 1 April 2010) were not compliant with EU law, HMRC had recently indicated that it would seek to withdraw its Statement of Practice 3/97 ("SP3/97").

SP3/97 is, however, actually a 'concession' from the strict requirements of section 842. Its withdrawal would potentially pose problems for existing ITCs holding significant investments in UK authorised unit trusts ("AUTs") and open-ended investment companies ("OEICs"). Without SP3/97, UK AUTs and OEICs held by ITCs would themselves need to satisfy all the requirements of section 842 (other than the listing requirement).

HMRC have now confirmed that, in light of these concerns, SP3/97 will continue to apply in its current form, until such time as it is reviewed. It is hoped that any legislation enacted to ensure that the conditions for ITC approval meet EC law requirements is drafted to be consistent with the existing SP3/97 practice.

Section 842 and Statement of Practice 3/97

The section 842 conditions are as set out in the box below.

SP3/97 confirms that (i) units in AUTs and shares in OEICs are treated as shares in companies for the purposes of the income test, and (ii) an ITC can invest more than 15% in a UK AUT or OEIC for the purposes of the 15% holding test provided that the UK AUT or OEIC itself meets the income test (so that the AUT or OEIC would not have to meet the prohibition test, or the 15% retention test).

HMRC change in practice

HMRC have recognised that limiting the 'concession' set out in SP3/97 to apply only to UK AUTs and OEICs is contrary to Article 56 of the EC Treaty (free movement of capital). Accordingly, HMRC on 7 April 2010 indicated in letters to stakeholders that they will recognise that an ITC can invest more than 15% in a company as long as that company would itself meet all of the section 842 conditions, other than the listing test and the residence test.

By stating an intention to withdraw SP3/97 (seemingly intended to have immediate effect), to be replaced in due course with revised guidance, concerns had been raised as to whether the ability for ITCs to have investments in or to invest more than 15% by value in other funds had actually been restricted (rather than widened) as a result.

SP3/97 makes it clear that, provided the UK AUT or OEIC itself "meets one condition" (the income test), an ITC can invest more than 15% in a UK AUT or OEIC. Our view is that any legislation enacted to replace SP3/97 should (i) maintain that the AUT or OEIC invested in by the ITC need only satisfy the income test, and (ii) extend this treatment to non-UK companies that are 'equivalent' to UK AUTs and OEICs.

Latest developments

HMRC have today confirmed in a further letter to stakeholders that SP3/97 will continue to apply until such time as legislation can be enacted to modify the ITC approval conditions. This should allay concerns for existing ITCs.

We are also hopeful that, at the earliest available opportunity (and perhaps as part of an overall review of the ITC regime), the ITC legislation will be amended to allow ITCs to invest more than 15% in non-UK companies that are 'equivalent' to UK AUTs and OEICs, provided that those non-UK companies themselves derive income wholly or mainly from shares and securities.

HMRC have also today confirmed that an ITC will be able to invest more than 15% in a unit trust scheme, provided the unit trust scheme itself meets all the section 842 tests, other than the listing test (and the residence test, as appropriate).

Section 842 tests:

  • The company must be resident in the UK (the "residence test")
  • The company's income must be derived wholly or mainly from shares or securities (the "income test")
  • No holding in an investee company, other than an another ITC or any company that would be an ITC but for the listing test below, may represent more than 15% by value of the company's investments (the "15% holding test")
  • The shares making up the company's ordinary share capital must be listed in the Official List of the UK Listing Authority (the "listing test")
  • The articles of association of the company must prohibit the distribution (as dividend) of surpluses arising from the realisation of investments (the "prohibition test")
  • The company must not retain an amount greater than 15% of the income it derives from shares or securities in any accounting period (the "15% retention test")