The HM Treasury document "Tax elected funds: summary of responses" and the July 2008 "Discussion Paper" can be found at http://www.hm-treasury.gov.uk/consult_taxelected_ funds.htm.

The Government has published a summary of responses to its discussion paper of 28 July 2008. That paper proposed a direct tax exemption for Authorised Investment Funds (AIFs), ie, UK tax resident authorised unit trusts and open-ended investment companies (see further our e-bulletin of 1 August 2008).

Background

AIFs are currently exempt from tax on chargeable gains but are taxed on income such as interest, overseas dividends and offshore income gains. The proposal outlined in July 2008 was that whilst an AIF would remain a taxable entity, defined streams of income within an AIF, which elects to be within the proposed new regime (a "Tax Elected Fund" or "TEF") would not be taxable.

Under the original proposal, an AIF would be eligible to irrevocably elect into the TEF regime, subject to meeting specific conditions. The principal condition being that the AIF would be required to meet a similar "genuine diversity of ownership" test to that required under the existing Property Authorised Investment Fund ("PAIF") regime. A TEF would need to identify its income into different streams, according to its source (mirroring in this regard the existing PAIF and Real Estate Investment Trust regimes).

The intended effect of the proposed direct tax exemption would be to move the point of taxation from the AIF to the investor, so that an investor in a TEF would be taxed as if he owned the underlying assets directly. The Government proposals were welcomed by the industry.

Further proposals

Herbert Smith LLP and other interested parties responded to the discussion paper, and a number of the concerns raised in our e-bulletin have been addressed and considered. In summary:

  • legislation will be introduced to enable a TEF to exit the regime in a future period;
  • the Government is not able to confirm whether a TEF would retain access to double taxation treaties. This would depend on the relevant treaty partner's attitude to such funds;  
  • it has been confirmed that a TEF will be required to identify its income into different 'streams' according to its source;  
  • whilst the Government believes that a TEF should provide information to allow investors to complete their self-assessment returns, it is willing to explore alternatives to the tax voucher system;  
  • the Government has rejected suggestions to remove the requirement for a TEF to distribute income each year;  
  • the Government has confirmed that all AIFs will be treated as medium or large entities for the purposes of the draft foreign dividend legislation published on 9 December 2008. Foreign dividends will therefore (subject to further reform on the issue in respect of individuals) be included in the same income 'stream' as UK dividends for TEFs;  
  • in response to the suggestion that TEFs should be allowed to receive a de minimis amount of property income, the Government has agreed to work with the industry to consider how this could be achieved;  
  • the Government intends to retain the bond fund regime and will continue to work with the industry as to how to deal with offshore income gains.  

The Government intends to publish draft regulations in early 2009 and therefore is not inviting further comments at this stage. However Sue Harper at sue.harper@hm-treasury.gov.uk is available for any questions regarding the proposed TEF regime.