On 17 September 2013, the final draft of legislation to change the tax treatment of unauthorised unit trusts was published. The Unauthorised Unit Trusts (Tax) Regulations 2013 (UUTs Regulations) are intended as both tax anti-avoidance and simplification measures. This article sets out the ambit of the UUTs Regulations and their impact on investors.
It should be noted at the outset that the UUTs Regulations only affect the taxation of income and of chargeable gains. They do not make any change to the current position in respect of other taxes, such as Value Added Tax. Furthermore, the UUTs Regulations only apply where the trustees of an unauthorised unit trust (UUT) are UK resident, meaning that the tax treatment of UUTs whose trustees are non-UK resident remains unchanged. Therefore these other taxes and trustees are beyond the scope of this note.
What is an unauthorised unit trust?
A UUT is any unit trust scheme established in the UK that is not authorised by the Financial Services Authority. A UUT is therefore not subject to limitations on its investment powers, other than any restrictions contained in its trust deed.
What is the current tax position of the trustees?
Income arising in a UK tax resident UUT is regarded as income of the trustees and not of the investors (the unit holders). Income tax is chargeable at basic rate, whether distributed or accumulated. The trustees are currently treated as making a “deemed distribution” to the unit holders representing the gross amount of the unit holders’ income after the deduction of basic rate income tax. The trustees account to HM Revenue & Customs (HMRC) for the tax deemed to have been deducted and receive relief for the gross deemed distributions to the unit holders against the trust income.
At present, a UUT is treated as if it were a company, but not one that is within the charge to corporation tax on chargeable gains. Instead, chargeable gains on disposal of trust assets are assessable to capital gains tax (CGT) on the trustees unless the UUT qualifies as an exempt unauthorised unit trust (EUUT). An EUUT is a UUT scheme in which all the issued units are held throughout a year of assessment by bodies which are wholly exempt (other than by reason of residence) from the charge to CGT (eg charities, local authorities and pension funds). Capital gains made by an EUUT are not chargeable gains. A UUT that is not an EUUT is known as a non-exempt unauthorised unit trust (NEUUT).
What is the current tax position of the unit holders?
Unit holders in a UK tax resident unit trust are treated as receiving their proportionate share of a UUT’s distributable income as “deemed payments” (regardless of whether this income is in fact distributed or accumulated). These are annual payments that have been subject to deduction of basic rate income tax.
How will the Unauthorised Unit Trusts (Tax) Regulations 2013 affect the position?
The UUTs Regulations will replace the existing primary legislation applicable to UUTs. The Government’s objective is to close the tax gap by introducing rules to prevent UUTs being used for tax avoidance. The rules do this by defining and providing different treatment for EUUTs and NEUUTs.
Exempt unauthorised unit trusts
The UUTs Regulations provide a clear definition of an EUUT. A UUT will be an EUUT, in relation to a period of account, if all of the following apply:
- The trustees are UK resident.
- Throughout the period, all of the unit holders are wholly exempt from CGT or corporation tax on chargeable gains (otherwise than by reason of residence) (the "exempt from gains" condition).
- HMRC has approved it as an EUUT.
The existing rules for the taxation of the income of EUUTs and their investors will broadly retain their current structure but changes will be made to simplify the rules and reduce administrative burdens. This will be done by simplifying the calculation of income and the basis of tax filing by EUUTs and removing the requirement for trustees to deduct tax from deemed payments to investors. The broad aim of the UUTs Regulations is for EUUTs’ accounts income, taxable income and (deductible) deemed distributions to be the same (or at least nearer than they may have been under the existing rules).
The actual levy of income tax at the level of the trustees will remain unchanged. The only material difference is the way in which the unit holders are treated as receiving the income: under the current regime they are treated as receiving it net of basic rate income tax, whereas under the new system they will receive the payments gross and account for tax through self-assessment.
The UUTs Regulations will also introduce rules to ensure that the exempt status of a UUT is not lost if an existing unit holder loses its own exempt status or an ineligible investor is inadvertently admitted. These rules will have the effect of ensuring that minor and inadvertent breaches are dealt with in a more proportionate way than the “cliff-edge” situation at present, where any breach can result in the loss of exempt status.
Non-exempt unauthorised unit trusts
NEUUTs are defined in the Regulations as any UUT that is not an EUUT. The UK resident trustees of NEUUTs will be treated as a UK resident company and the unit holders’ rights as if they were shares in that company. The NEUUT will be brought within the charge to corporation tax at the main rate in relation to both the income and gains of the trustees. Unit holders will no longer be deemed to receive distributions of income and distributions from NEUUTs will be treated in the same way as corporate dividends.
How will investors be affected by the changes?
The broad effect of the changes introduced by the UUTs Regulations is to simplify the rules for EUUTs and to reduce the administrative burdens for them and their investors.
The removal of the requirement for trustees of an EUUT to deduct tax from deemed payments to investors means that the unit holders will receive payments gross and account for tax through self-assessment. Exempt unit holders will no longer need to claim repayments of tax withheld on deemed payments, freeing them (and the EUUT) of an administrative burden. A UUT that wishes to benefit from these changes will be required to apply to HMRC to receive approval as an EUUT.
The changes to the treatment of NEUUTs, and in particular their taxation at the main rate of corporation tax, reflect the perception that, generally, NEUUTs have been used for tax avoidance while EUUTs have been used as genuine investment vehicles. Given the unfavourable treatment of NEUUTs under the new regime, it seems unlikely that UUTs will be established in future other than to qualify as EUUTs.
The UUTs Regulations will come into effect on 6 April 2014, save that the measures defining EUUTs and installing the approval process will come into force the day after the Regulations are made.