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Financial Institutions e-briefing: authorised tax transparent funds

    • Financial services and markets regulation - UCITS V
    • Financial institutions

    11-07-2013

    Authorised Tax Transparent Funds

    It is now possible to launch authorised tax-transparent funds in the UK. The FCA’s rules for authorisation of tax-transparent funds (called Authorised Contractual Schemes (“ACS”) in the legislation) came into force on 1 July. For further information view the Authorised Contractual Schemes (Handbook Amendments) Instrument 2013 document. This follows the various tax regulations (Statutory Instruments 2013/1400-1402) and the main regulations Statutory Instrument 2013/1388.

    Background on Authorised Tax Transparent Funds

    The government announced its intention in the 2011 Budget to introduce a new regulated, tax-transparent fund vehicle primarily to facilitate the establishment of master funds under the UCITS IV Directive but with the potential for much broader use. The 2011 announcement was both preceded and followed by various meetings with HM Treasury (“HMT”) and HM Revenue & Customs (“HMRC”) covering their tax, legal and commercial aspects in which Eversheds participated. 

    It was decided that the UK should have two alternative tax transparent fund structures:

    • an authorised co-ownership scheme, which would be a brand new type of contractual scheme based on a co-ownership model; and
    • an authorised limited partnership (ALP), which would be similar to existing limited partnerships. 

    The government was clear from the outset that the tax-transparent fund should not only be available as a UCITS vehicle but also as a NURS and a QIS.  It wanted the new tax-transparent fund structure to improve the UK’s competitive position by providing fund vehicles that can perform an equivalent role to Luxembourg FCPs (fonds commun de placement) and Irish CCFs (common contractual funds), that is to pool money while ensuring that all investors receive the correct returns taking into account their varying entitlements to reduced withholding taxes under applicable double tax treaties.  ACSs are available not just to act as tax-transparent master funds in master/feeder structures, whether UCITS or non-UCITS, but also for use as investment funds in their own right.

    Anticipated uses for them are to pool insurance companies’ portfolios enabling them to streamline their investment operations, and also for pooling pension money both within corporate groups and commercially, though it was always thought that other uses for them would emerge in due course.

    The government published its first consultation on tax-transparent funds in January 2012 setting out its intentions and seeking information about their potential benefits as well as their proposed legal structure (draft regulations were included) and tax treatment.  This elicited many positive responses as well as detailed comments.  HMT/HMRC published a revised set of draft regulations in July 2012 covering both the legal structure for tax- transparent funds, and also draft regulations dealing with their direct tax, stamp tax and VAT treatment. This was followed, after much work, with a further set of draft regulations in January 2013. Although the final regulations have taken a long time to be finalised, a number of practical and some complex legal issues have been resolved along the way so the end result is both practical and robust.

    Meanwhile, in March 2012, the FSA’s quarterly consultation included material on the changes it proposed to COLL to facilitate the introduction of tax-transparent funds.  It proposed that the entire COLL Sourcebook should, with some minor exceptions, apply to them.

    Tax treatment

    HMT/HMRC always intended that tax-transparent funds would work in tax terms in broadly the same way as existing equivalent vehicles do. The various tax regulations required (which are all in substantially the same form as the initial drafts) were made in June 2013.

    Co-ownership schemes will be transparent for income tax purposes but be deemed to be companies, that is opaque, for capital gains tax purposes, just as FCPs and CCFs currently are. Consequently, taxable UK participants in co-ownership schemes will be regarded as owning an interest in the scheme and will be liable to tax on gains on disposal of that interest, rather than being treated as owning a share of all the underlying assets. Life offices can claim capital gains tax relief when transferring assets to a co-ownership scheme.

    Transfers of securities to a co-ownership scheme in consideration for an issue of units in it are exempt from SDRT and stamp duty. Further, transfers of securities between sub-funds in an umbrella co-ownership scheme, will be exempt too (this relief was granted to match the position in FCPs). There is also an exemption for the transfer of units in a co-ownership scheme. The special (shortly to be abolished) SDRT regime for collective investment schemes in Schedule 19 Finance Act 1999 does not apply to them. There are currently no specific rules for SDLT and co-ownership schemes, but the Association of Real Estate Funds (AREF) is currently working with HMT and it seems likely that this will result in an appropriate SDLT regime for them.

    The supply of management to tax-transparent funds is VAT exempt, just as it is with OEICs and authorised unit trusts.

    On the international tax front, the co-ownership schemes have been designed in such a way that they should generally qualify for tax-transparent treatment in other jurisdictions, although ultimately this is a matter for their local fiscal authorities to determine. We expect co-ownership schemes to be regarded as tax-transparent in at least all the jurisdictions that accept the tax-transparency of FCPs, and then investors in them will qualify for double tax convention-reduced rates of withholding tax on their underlying investments. So, for example, a UK pension fund investing through a co-ownership scheme into US equities will benefit from 0% withholding tax under the US/UK double tax treaty. HM Revenue & Customs intend to write to their foreign counterparts to explain the new schemes and to follow this up with informal contacts to seek views on whether these jurisdictions will treat UK co-ownership schemes as tax transparent.

    There are no special direct tax rules for ALPs, consequently ALPs will be transparent for both income and gains tax purposes, just as other limited partnerships are, so each taxable limited partner in an ALP will be liable to income tax on the appropriate share of the ALP’s income and capital gains tax in respect of the appropriate share of all its gains each year. We expect an ALP to be treated the same in international tax terms as any other UK limited partnership, for instance they would generally be tax-transparent for US tax purposes but regarded as opaque in several countries such as France.

    Legal structure

    Co-ownership scheme

    The essence of a co-ownership scheme is that, as the name indicates, the investors own the scheme property as co-owners (although it will be held for them by the depositary). The scheme documentation will regulate this co-ownership relationship as well as providing for the scheme property to be managed by an authorised fund manager. Co-ownership schemes may be in standalone or umbrella form. The regulations limit each investor’s liability for the debts of the scheme to the value of that investor’s units from time to time, and the assets and liabilities of each sub-fund in an umbrella structure will be protected.

    Co-ownership schemes will operate in most practical regards like authorised unit trust schemes. Units in a co-ownership scheme will be freely transferable unless the scheme documentation provides otherwise; this is a reversal of earlier plans where most types of transfer were to be prohibited (the issue arose because tax-transparency in the Netherlands requires this restriction).  Box management will consequently also now be possible.

    Authorised limited partnership

    ALPs will essentially be the same as regular limited partnerships but with three improvements achieved by specific amendments to the Limited Partnership Act 1907 applicable only to ALPs.  These are that:

    • limited partners in an ALP will be able to redeem their interest in it without remaining contingently liable for the partnership’s debts. Consequently, they will be able to invest and withdraw capital in the same way as in other collective investment schemes, rather than making and redeeming loans as they would for a regular English limited partnership;
    • the general partner (which under the regulations will be the operator of the scheme) will not be liable for the debts of the limited partnership (unless it is guilty of the sort of wrongdoing which would result in a director of an insolvent company becoming liable for its debts); and
    • the rules regarding publishing partnership changes in the official Gazette are disapplied.

    Administration

    Tax-transparency is not as simple as it sounds; investors will need full information on their respective share of the income to meet their income tax obligations. And in the case of an ALP, they will need equivalent information about their respective shares of capital gains (and losses). This is obviously complex from an administrative perspective and is, we understand, best achieved by using classes to aggregate all investors with the same tax treatment in order to facilitate both double tax treaty relief at source and, where necessary, reclaims. It also explains why investors are limited to professional investors (as per MiFID) or investors investing at least £1m.

    Authorisation

    The process for having a tax-transparent fund authorised will follow the same process and timings as authorisations of UCITS, NURS and QIS at the moment.  The fee scale for applications will be the same.  The FCA have published a specific form, Form 261C, for applying for authorisation of a tax-transparent fund.  Form 261Q should be used for subsequent changes to a tax-transparent fund.  The documents which will be required to establish a tax-transparent fund will vary dependent on whether a co-ownership scheme or a limited partnership is to be established.  For a co-ownership scheme the following will be required:

    • Prospectus;
    • Draft Instrument;
    • Form 261C;
    • KIID, NURS KII or other pre-contractual document;
    • Solicitor’s Certificate;
    • Model Portfolio.

    For an ALP the following documents will be required:

    • Partnership Deed;
    • Prospectus;
    • Certificate of Registration
    • KIID, NURS KII or other pre-contractual document;
    • Solicitor’s Certificate;
    • Model Portfolio.

    Eversheds are working with the IMA to prepare model documentation.

    The launch of authorised tax-transparent funds in the UK is a welcome development, as is the flexible approach of HMT and HMRC in ensuring these products are competitive. If you would like further information please contact your usual financial services team contact or visit our Financial Institutions pages.

    For more information contact

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