HM Revenue & Customs ("HMRC") this week made a surprise announcement regarding the tax treatment of fee rebates and similar payments made to UK investors in collective investment schemes and other investment products. The announcement advises that such payments are taxable and, in the case of payments made by UK entities, should be paid to investors subject to a withholding in respect of basic rate income tax. This announcement is of immediate relevance as it affects payments made for the tax year commencing 6 April 2013.

The Announcement

On 25 March, HMRC published Revenue & Customs Brief 04/13 which concerns the tax treatment of rebate payments made to investors in collective investment schemes, insurance policies and other investment products by fund managers, fund platforms, advisers and any other persons acting as an intermediary between funds and investors. Such payments include the passing on of trail commissions to investors and may take many forms including fee rebates, loyalty bonuses or the award of additional units.

Although the technical position has been the subject of debate, much of the investment management industry has treated such payments as non-taxable in the hands of investors. However, HMRC’s brief advises that this approach is incorrect and that such payments are taxable "annual payments" for investors.

While the taxation treatment of trail commission had been the subject of consultation with certain industry bodies, the extension to the tax treatment of fee rebates in general including in relation to the alternative fund management sector was unexpected.

The announcement does not concern the payment of "cashback" or other discounts from initial charges which are not taxable and which reduce the initial cost of an investment for capital gains tax purposes.

Annual Payments

In general terms, "annual payments" are recurring, income payments received as "pure income profit". In other words, they are payable to the recipient without the recipient having to do anything in return (over and above the making of an investment). Annual payments are subject to a particular tax treatment which requires the payer to make the payments after the deduction of basic rate income tax (20%). Recipients of annual payments are required to account for any higher or additional rate tax through their self assessment tax returns.

Impact of the Announcement

HMRC understands that the practice of making trail commission or rebate payments to investors is widespread and that fund managers and other relevant payers have not generally deducted basic rate tax from the payments. HMRC will not seek to collect tax for earlier years from either the payers who should have deducted tax or from investors who should have declared any higher or additional rate tax payable.

However, any payments made in the tax year commencing 6 April 2013 and in future years should be made subject to the necessary deduction and should be included in self-assessment returns for the period.

Investments in Offshore Funds

Where an investor receives payments from an intermediary with respect to their investment in an offshore fund then the tax analysis will be the same as for payments received in respect of an investment in a UK fund. However, if a taxable annual payment is received directly from an offshore fund or offshore intermediary, the offshore entity will not be required to withhold in respect of basic rate tax and the recipient must account for all tax due through self-assessment.

Non-Resident Investors

Non-resident investors receiving payments from a UK payer may also be subject to a 20% reduction in rebate payments unless they can take advantage of a double tax treaty.

Practical Steps

Given the almost immediate application of this change, fund managers and affected intermediaries should take the following steps as a matter of priority:

  • Identify any payments to be made to investors which may be considered to be in the nature of "annual payments".
  • Consider whether any payments to be made in the near future can be deferred to allow time to assess the impact of the HMRC announcement.
  • If payments must be made, ensure that such payments are made subject to the deduction of basic rate income tax and notify investors of the reason for the change of policy.
  • Consider whether existing arrangements should be amended to avoid the impact of the announcement, for example by discounting fee rates rather than paying a rebate. This would both prevent a withholding tax obligation for the payer and prevent a tax liability for the investor.
  • In the case of offshore funds, consider whether the withholding obligation can be avoided by making any payments directly from the offshore fund or through an offshore intermediary (though this would not remove the investor’s tax liability).

Further Comment

Given HMRC’s increased consultation with the investment management industry in recent years, it is surprising and unfortunate that this announcement has been released without full consultation and without giving the industry sufficient time to implement any changes which may be necessary. Dechert will work with industry bodies to make representations to HMRC on this issue and it is to be hoped that HMRC will allow fund managers and intermediaries some grace when enforcing the announcement for the 2013/14 tax year.