Summary of responses to draft published on 14 December 2005
(including information on changes in response to comments introduced for the
draft as laid before Parliament on 13 February 2006).
1. Authorised Investment Funds (AIFs) comprise Authorised Unit Trusts and Open-ended Investment Companies. These are collective investment schemes authorised and regulated by the Financial Services Authority (FSA).
2. Following the publication by the FSA of a new sourcebook for AIFs (COLL - coming into effect over the period from April 2004 to February 2007), Inland Revenue published a technical discussion paper on 21 July 2004 to explore some of the issues that might arise from the new sourcebook.
3. 28 replies were received to that technical discussion paper, and a summary of responses (PDF 166K) was published on 25 November 2004.
4. Having considered the responses to the technical discussion paper it was decided to proceed with the modernisation of the taxation of AIFs, and powers were provided in Finance (No 2) Act 2005 to enable this to be taken forward by regulation.
5. A draft of the proposed regulations was published on 14 December 2004 for consultation and 17 responses have been received. A final draft of the regulations was laid before Parliament on 13 January 2006.
6. The following paragraphs summarise points raised in the responses to the draft regulations and indicate where, in response to points raised, changes of substance have been made in the draft laid before Parliament.
7. There was a recognition that consolidating the detailed arrangements for the taxation of AIFs and their investors into a single set of regulations, whilst retaining the main taxing and relieving provisions in primary legislation, is easier to navigate, and simpler to use.
8. In addition to a number of detailed drafting suggestions, a number of concerns were expressed about the draft regulations published on 14 December 2005.
9. At present an AIF that chooses to make an interest distribution to a UK resident investor is obliged to do so under deduction of tax at the lower rate of income tax. Payment to non residents can be made without such a deduction.
10. The draft regulations proposed to extend the ability for funds to pay interest distributions gross to UK residents who are non taxpayers. This would be more efficient for non taxpayers, who would no longer have to make a claim for the money withheld. It would also avoid the burden on HMRC of handling those claims. This would align the treatment for interest distributions made by AIFs with that of interest paid by banks and building societies. It was proposed to permit this from 6 April 2006.
11. A number of respondents requested that the provision of this facility be made voluntary for funds, as it may not be cost effective for them to make changes for a very small number of investors. Others said that, as they only had a small number of overseas investors to whom gross payments were made, they were able to accommodate these by manual intervention. A significant increase in the number of gross payments would require system changes.
12. Most of the respondents made the point that such a change would require system changes, and would be extremely difficult to implement by this April. In recognition of this, implementation has been delayed until 6 April 2007. This will give the industry time to prepare.
13. As a QIS is a non retail scheme available only to sophisticated and institutional investors it is less highly regulated by the FSA and has wider investment flexibility. Accordingly, to prevent investors from gaining a tax treatment intended for pooled investors, whilst possibly retaining some of the control that is a feature of direct investment, a special rule has been put in place to treat significant investors in a QIS differently. Investors with 10% or more of the units in a QIS will be subject to an annual income tax charge on movements in the capital value of their holding.
14. A number of exclusions from this 10% rule were provided for in the draft regulations, including pension funds and charities. A number of respondents suggested that both QIS and NURS (Non Undertakings for Collective Investments in Transferable Securities (UCITS) Retail Schemes) should also be excluded. This would enable other QISs and NURSs to invest in “fund of fund” type arrangements without coming within the scope of the 10% rule.
15. After consideration of this, the exclusions have been extended to allow a QIS scheme to invest in another QIS and not be within the 10% rule. However, there has been no extension of the list of excluded bodies to include NURS. This is because there remain concerns that to do so would provide an easy way to circumvent the 10% rule.
16. Some respondents also considered that there was a risk of a double tax charge being levied in cases where the owner of the units held them for trading purposes (including the fund manager’s “box”). This concern has been addressed by excluding those unit holders chargeable to tax on sales of units as trading income.
17. Concern was expressed that the list of those excepted from the 10% rule should be expanded to account for both seeding and winding up situations.
18. With regards to seeding, it was said that a significant investor may seed a fund and that many investors look for a track record before deciding whether or not to subscribe to a fund. It was suggested that six months was insufficient and that new funds could take longer before the initial investment from those “seeding” the fund on launch might have their holding diluted below the 10% holding level.
19. In recognition that it can take time for funds to become established the exception to the 10% rule for investors in newly launched funds has been extended to 12 months.
20. A similar change has not been made in respect of winding down a fund at this time. This can be considered further in discussion with the industry.
21. Some respondents felt that the definition of measuring dates was confusing. Some changes have been made in the draft as laid before Parliament to address this point.
22. A number of concerns were expressed about the ability of investors to monitor how close they may be to the 10% holding limit. Whilst it will be necessary for an investor close to the limit to monitor the size of the fund, funds are required to make information available to investors. Under Self-Assessment investors are obliged to seek out necessary information.
23. It was also said by some respondents that, in the case of ‘inadvertent breaches’ of the 10% rule more time should be allowed for investors to reduce their holding before being caught by the rule. (An inadvertent breach is where the holding increase above 10% through no action of the investor – for example where other investors sell out units.)
24. Objections were raised to the permanent status of a holding as substantial once it had been identified as a substantial QIS holding. However, to remove this could lead to holdings constantly moving in and out of the ‘substantial’ category with consequent complexity of tax treatment. It is also the case that the rule is intended to discourage investors from obtaining a substantial holding and to make this change would limit the deterrent effect of the rule.
25. The draft regulations apply loan relationship rules to interest distributions and maintain the previous absence of a carry back provision.
26. Some respondents recognised that a limitation would be required but suggested that a fund should be allowed to carry back such part of any non-trade loan-relationship deficit as was not attributable to the payment of interest distributions. It was decided that the complexity that would be added by accommodating this outweighed the benefits given the remote likelihood of such an excess arising and fund managers wanting to revisit the previous year’s tax computation.
27. It was noted by some respondents that provisions for AUTs converting to OEICs had been replicated in the draft regulations and suggested that these should be extended to all AIF-AIF amalgamations. As this is a further development to the regime we have not been able to consider it fully at this stage and will ask for further information from the industry.
28. A number of respondents raised the more general issue about the taxation of property within AIFs, and how this might be impacted by the possible introduction of Real Estate Investment Trusts. As we have said before, consideration of any wider changes to the way in which property might be taxed within AIFs is being taken forward in parallel with the debate on REITs.
29. In addition to the above points a number of helpful comments were made on points of detail. Where appropriate these have also been reflected in the draft laid before Parliament on 13 February 2006.
30. It is hoped that discussions with Industry bodies will continue and that as the regulations are subject to future revision this will be informed by industry expertise.
31. HMRC would like to thank all respondents for their contributions
