The HM Treasury document "Trading and investment for Authorised Investment Funds" can be found at http://www.hm-treasury.gov.uk/consult_tradinginvestment_ funds.htm.

Further to the announcement in this year's Pre-Budget Report, the Government has published a consultation paper setting out legislative proposals to provide increased certainty as to whether transactions carried out by Authorised Investment Funds (AIFs) are trading or investment.

Background

AIFs are taxed only on income and are exempt from tax on capital gains. However, there is currently a risk under UK tax law that if AIFs undertake certain transactions, they may be held to be trading for tax purposes. This would have a detrimental tax effect because the gains on those transactions would be taxed as income on that trade rather than being exempt from tax on capital gains. Moreover, if particular transactions are held to be trading, this can result in all of the transactions of the AIF being treated as trading for tax purposes (known as the 'precipice problem').

This inherent uncertainty has caused much concern in the industry and may even discourage AIFs from locating in the UK (since other jurisdictions such as Luxembourg and Ireland do not make the same distinction). In response to these concerns, HMRC published guidance in the 2007 Pre-Budget Report on the types of transactions which could be undertaken by AIFs without risk that they would be held to be trading.

Proposals

The Government proposes to introduce a 'white list' of financial transactions which AIFs that meet a 'genuine ownership test' can undertake with certainty that they will not be taxed as trading with respect to those transactions. The list is intended to include as full a range as possible of financial transactions. However, in order to prevent abuse, the Government does not intend to extend it to other types of transactions.

'White list' transactions will be 'ring-fenced' for tax purposes, ie, irrespective of any other transactions which the AIF undertakes, they will always be taxed as investment. On the other hand, 'non-white list' transactions will not automatically be taxed as trading, but instead will be taxed either as investment or trading according to general principles. Furthermore, the legislation will remove the precipice problem: if an AIF undertakes a 'non-white list' transaction and that transaction is held to be trading, only that particular transaction will be taxed as trading.

The types of transactions which the Government intends to include in the 'white list' are detailed at Annex A to the consultation paper. These include the following broad categories:

  • shares and stock
  • loan relationships
  • derivative contracts
  • units in collective investment schemes
  • securities of any other description  
  • buying or selling foreign currency  
  • carbon emission credits  

These proposals do not extend to investment trust companies which is disappointing.

Draft legislation will be published in early 2009 and, subject to responses, the changes are intended to come into force after Budget 2009. Comments are welcome either before or after publication of draft legislation and should be sent to Lee Harley at lee.harley@hmrc.gsi.gov.uk.