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Eversheds Sutherland property column: June 2020

  • United Kingdom
  • Real estate
  • Real estate finance - Real estate briefing
  • Real estate investment - Real estate briefing
  • Real estate sector

09-06-2020

Authorised contractual schemes: a rare sighting?

Background

Seven years ago the market was given the power to create co-ownership authorised contractual schemes (ACSs). Much has changed since then, but what has not happened is the expected proliferation of ACS structures across theproperty world. Scottish Widows, Canada Life and Royal London were early adopters of co-ownership ACSs, andthe consolidated local government pension schemes (LGPS) are extremely interested in them, but why not others?

ACSs' advantages

It is worth remembering why this structure was developed. This type of vehicle had been sought for many years, as an onshore competitor to the regimes offered in Luxembourg and Ireland. Importantly for insurance companies, it enabled them to pool life funds (the first property ACS pooled six separate ones) in a tax-transparent authorised scheme, giving them economies of scale, by allowing them to participate in each underlying asset. This is not participation in the block-chain sense, but rather ownership as tenants in common. With many life and pension funds decreasing in size, this enabled them to recapture the benefits of scale, with lot size, management fee and outsourcing pricing advantages.

Unlike other UK authorised structures, the beauty of the ACS is that it is tax-transparent for income purposes, thereby preserving each investor's own tax status. Critically, withholding tax rates can be preserved. Distributions are an accounting exercise, rather than being asset-led, again allowing for greater flexibility. The pricing and accounting complexity is at fund level. To summarise, accounts are pooled for investment, but separated for investors. ACSs also benefit from the advantage of no VAT on management fees, as with other UK authorised funds. For life and pension funds, this has been a material attraction. For CGT, units in co-ownership ACSs are treated as assets, while there is no CGT at the portfolio level within the ACS.

While we had, by 2016, already established the first property co-ownership ACS SDLT-free by using group relief because they were then transparent for SDLT purposes, such transparency brought various difficulties. Consequently, the rules were then changed to make them SDLT-opaque but permitting SDLT relief on the initial contribution(s) of assets into an ACS. Though there is a clawback regime, the granting of such reliefs is increasingly rare from the Treasury, increasing the attraction of an ACS.

Conversion issues

Given property ACSs have many upsides, why have we yet to see a rush to create them (to date there are only three life company plus one LGPS ACSs)? It is worth considering some of the issues with ACSs that need to be overcome by good advice before clients can take advantage of its benefits.

As with all fund conversions, ACSs require significant investment in cost and time. Working on the first property scheme, it was eye-opening to see the client effort required to organise all aspects of the fund to maximise its ultimate benefits. For example, software must be adjusted and thoroughly tested to ensure all records can be moved overnight. The depositary may not accept some assets, usually due to environmental or ethical concerns. Some assets may need consent, or enfranchisement procedures may apply. Some properties may therefore be left behind, raising the question of what to do then with these strays sitting outside the fund structure.

Some tenants use the change in landlord as an excuse to delay rent payment. With often thousands of tenants, the administrative burden of getting rent authority letters out and correctly addressing and delivering rent demands is enormous, even with artificial intelligence.

Conversion brings the opportunity to audit the portfolio. Yes, an advantage, but locating records such as VAT elections and section 198 of the Capital Allowances Act 2001 elections needs people power of a scale often long pared back to reduce costs. A willing and trusted authorised depositary to hold the properties' legal title is also vital. The depositary must attract the ready approval of landlords and third parties to ease initial contributions and future acquisitions, and be able to cope with new levels of transactional and financial reporting. Depositaries are used to acting for authorised property unit trusts (APUTs) and property authorised investment funds (PAIFs), but have taken time to familiarise themselves with the ACS's different demands.

Learning from ACS experiences

ACSs have an unusual structure. They are contractual arrangements, not trusts, and are not legal persons. Explaining that a fund without legal personality is good for the money can be difficult. The Financial Conduct Authority's COLL regulations help here, making the operator liable for the ACS's debts where it has entered into an authorised contract, although the definition of "authorised contract" has yet to be tested. However, the obligation to pay is limited to the value of the ACS's assets. The investors themselves are not liable, but could lose investment value as the operator draws on scheme assets to meet liabilities. The effect is no different to a limited company, except that a third party is paying such debts.

Another common issue is the way the depositary holds the assets. Whether holding directly or via nominees, it will want to limit its liability to the value of the ACS's property. This is the same for any trust and ought not to be an issue. However, it can cause problems with certain counterparties. For example, local authority lawyers may initially feel unable to accept such a limitation, but they usually accept it when they realise it leaves them in a better position than with most limited companies. A billion pound property fund with liability limited at fund level is still an excellent counterparty.

The ACS's regulatory reporting requirements mean more reporting for panel lawyers than pre-conversion. It's not arduous, but demands accuracy and well-kept records.

Conclusion

We hope that, in coming months, more ACSs will be launched to compete with Luxembourg FCPs and Irish CCFs, principally by the establishment of three or four more LGPS ACSs. Increased volume should see the structure become widely accepted and better understood in the property market, leading to yet more funds converting to take advantage of this onshore tax transparent structure.