Background
The idea of a new UK tax transparent fund vehicle has been discussed for some time but HM Treasury has now released a consultation document and draft legislation addressing the issue.
The European Union ("EU") Undertakings for Collective Investment in Transferable Securities ("UCITS") IV Directive ("UCITS IV") introduced a framework of master/feeder arrangements applicable to UCITS that invest in other UCITS. A UCITS is a special type of authorised fund targeted at retail investors which meets the criteria laid down by the EU and which can then operate throughout the European Economic Area ("EEA"). For the master/feeder arrangements to work effectively, the master fund must be transparent for tax purposes. However, the UK Financial Services and Markets Act 2000 ("FSMA") does not currently allow for the authorisation of a tax transparent vehicle and, accordingly, a master UCITS under the master/feeder rules cannot be established in the UK, putting the country at a competitive disadvantage in comparison to its European neighbors.
Although it has been announced as a fund vehicle, the new scheme will have limited application in the context of the wider private equity and hedge fund business. This is not something that will replace the limited partnership as a typical UK private equity vehicle. This new vehicle is targeted at investors wishing to invest in regulated onshore structures in the UK.
Summary
According to the consultation document, the new fund will take the form of either a co-ownership scheme or limited partnership. Both will be fiscally transparent and can be used as a UCITS fund, a non-UCITS retail scheme or a qualified investment scheme, the last two being other forms of authorised investment fund.
In a co-ownership scheme the participants will own the assets beneficially as "tenants in common" (or the Scottish equivalent). Legal title will be held by a custodian. A co-ownership scheme must not constitute a body corporate, a partnership or a limited partnership. Scheme assets will be acquired, managed and disposed of directly on behalf of the participants by the manager. The liability of participants for debts arising from the acquisition or disposal of scheme property will be limited to the value of their units.
A partnership scheme will be a limited partnership under the Limited Partnership Act 1907 (the "Act"). However, amendments will be made to the Act so that, among other things, partners will be able to redeem their partnership units before the partnership is wound up and without retaining liability for any debts of the partnership (under the Act liability is retained to the extent of the amount withdrawn from the partnership), and their liability for the debts of the partnership will be limited to the value of their units at the time the debts fall to be discharged.
Regulation
Provisions for the establishment and authorisation of these contractual schemes will be set out in a proposed set of regulations. These regulations are set out in a draft statutory instrument known as The Collective Investment in Transferable Securities (Contractual Scheme) Regulations 2012 ("Contractual Scheme Regulations"). These will ensure that tax transparent funds will be regulated in a similar way to an authorised unit trust. To date, the only types of schemes available to be established in the UK as authorised funds have been unit trusts and open-ended investment companies. The Contractual Scheme Regulations amend FSMA and other primary and secondary legislation, to permit new forms of authorised funds to be established; namely, co-ownership schemes or partnership schemes or non-UCITS retail schemes. The consequence is that an authorised contractual scheme will be subject to similar restrictions on promotion, authorisation, FSA rules and rules on alterations and revocation of authorisation as existing authorised funds.
Taxation of the fund
The tax transparent fund will not be subject to corporation tax, income tax or capital gains tax. A liability to stamp duty and/or stamp duty reserve tax (SDRT) may arise on the acquisition of assets liable to UK stamp duty/SDRT. If so, the duty will be paid by the scheme manager on behalf of the participants. However, it is proposed to provide limited relief from stamp duty and SDRT if the fund acquires shares or securities in exchange for issuing units in the fund or if the fund acquires shares or securities and has only charitable investors. Other reliefs from stamp duty and SDRT will be considered as part of the consultation process. Reliefs will be subject to an anti-avoidance rule.
The transfer of units of tax transparent funds will be outside the SDRT charge that applies to surrenders or transfer of units in unit trusts and open ended investment companies under Schedule 19 to the Finance Act 1999 and the scheme manager's management charges will be exempt from VAT.
Taxation of investor
Tax transparency means that, for direct tax purposes, investors will be treated as if they had invested directly in the underlying assets. Tax exempt investors, such as pension funds and charities, may therefore be able to invest in a UK vehicle that does not result in the tax inefficiency caused by overseas withholding tax suffered by a UK opaque fund.
UK resident investors will be taxable on income as it arises. However, for capital gains tax purposes (but only so far as co-ownership schemes are concerned), rules will be introduced so that investors are treated as owning an interest in the co-ownership scheme rather than an interest in each of the underlying assets. The effect of disapplying the usual "look-through" treatment for capital gains tax purposes is that capital gains and losses will arise not when scheme assets are acquired or disposed of, but on disposal of the interest in the scheme. Transparent treatment will continue to apply for partnership schemes, to ensure that the tax treatment of limited partnerships will remain consistent.
Non-UK resident investors will also be taxable on income as it arises, but will not generally have a UK tax liability.
Tax will not be withheld from income accumulated in or distributed from the fund except where income arises from real property situated in the UK and the participant is not resident in the UK. In that case the manager will be required to withhold tax at the basic rate (currently 20 percent) and account for that tax to HM Revenue & Customs.
HM Treasury assumes that the tax transparent fund will be considered fiscally transparent in all jurisdictions. Accordingly, HM Treasury confirms that it will be for the investors, rather than the fund, to assert any rights under a UK double tax treaty in respect of any withholding from non-UK source income payments or imposition of tax on non-UK source gains.
Comment
The consultation process ends on 19th March 2012 with legislation expected in the summer. The new funds will have limited application but certainly serve the intention of the legislature, namely to ensure that the UK remains competitive under UCITS IV. Issues have been raised regarding the somewhat limited exemptions from stamp taxes and the assumption of transparency in other jurisdictions, and it remains to be seen how these will be addressed in the consultation process.
If you would like to discuss the new UK tax transparent fund vehicle or related matters generally at any time, please contact any of the lawyers listed on this alert or the member of the Proskauer Private Investment Group or Tax Group with whom you normally consult on these matters.
* * *
IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.
This publication is a service to our clients and friends. It is designed only to give general information on the developments actually covered. It is not intended to be a comprehensive summary of recent developments in the law, treat exhaustively the subjects covered, provide legal advice, or render a legal opinion.