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Pbr can change the fund landscape

While it may not have been as attention-grabbing as headline cuts in VAT, the Government did make a number of tax concessions and planned changes on funds in last week’s pre-Budget report. And these changes may just help intermediaries in terms of choice for clients as well as in their tax planning.

First up is the smoothing of some of the problems in the property authorised investment funds (Paif) regime that was introduced in the spring. The new regime is attractive to investors, in that property funds held in tax wrappers such as Isas or pensions, would no longer suffer the withholding of 20 per cent of the income distributed.

However, since its introduction, not a single group has converted their existing property funds because of a few hiccups in the legislation that have made it unattractive. The Government is now looking to address these, some immediately and some still to come.

Big corporate investors in funds have not been interested in the conversion of existing property funds to the Paif regime as they would suffer double taxation under it – not to a great degree but enough not to be interested. Under PBR changes, that double-taxation issue has gone away.

Still outstanding though is a problem for the retail side of property funds. Under the Paif regime, fund managers must send tax vouchers to clients, outlining the income distributions. These distributions must be split into three parts detailing rental income, dividend and other (interest).

A headache for groups but the problem does not end with them. Funds are bought through supermarkets or platforms, on behalf of clients and generally through nominee arrangements. This means this distribution division into three would have to happen at each level before it gets to the end-client, not only creating an operational issue for groups, IFAs and platforms but also increasing the chances of error down the chain.

While not a taxation problem per se, the operational nightmare of this division, which would have to be sent down the chain at every distribution date on a fund – be it quarterly or annually – has certainly been a deterrent for groups to want to switch their funds over to Paif.

But the Investment Management Association said it is in very positive talks with the Treasury on this point, working to devise a simpler method of conveying the information to investors. The IMA expects to see resolution in this matter soon and the barriers to groups switching to the more tax- efficient Paif regime could be settled by the spring.

That would mean advisers have an easier time in determining the tax position for clients in property funds but it could also see the universe of options open up in this area as groups with offshore property portfolios may look to bring them onshore.

Also being cleared up in the PBR was the age-old uncertainty of what constitutes a trading fund and what is an investment fund. This has been much debated over the years as the taxation of a fund deemed to be trading is far more onerous than an investment fund and yet the definition of what is “trading” has always been quite cloudy.

At times, groups have wondered if the level of turnover in their portfolios would lead them into trading territory, causing some managers to place caps on turnover levels in funds. With the greater use of derivatives in retail funds and the way in which these derivatives are being used, the issue has come under even greater scrutiny.

Last autumn, the Revenue gave some indication of what it saw as “trading” but still there has been no legislative certainty. The IMA now expects a consultation paper in this area to be issued next month that could once and for all put this fear to rest and free up managers in their investment processes.

Another change enabled by the PBR was in the professional qualified investor scheme rules, which will now abolish the restriction of no one investor owning more than 10 per cent of the fund. The flexible Qis has been allowed for years now but few groups have opted for this structure, aimed at professional investors, because of this 10 per cent rule. Not only is it hard to monitor such a position in an open-ended vehicle but a 10 per cent position is also easy to exceed in any new launch.

By eliminating this barrier, so long as groups prove the fund is widely available and not an attempt to run a private unit trust, the more flexible Qis may find more interest from providers as well as investors such as fund of funds managers.

The attraction of a Qis over Ucits funds is their greater flexibility on holdings. For example, a Qis, which has the same governance structures as authorised funds, can hold physical gold or physical property with no prescribed limits while a Ucits fund can hold neither and a non-Ucits retail fund is somewhere in the middle of the two.

Still another point that was addressed in the PBR, although the details of which have yet to be seen, is the taxation of foreign dividends and how this will affect onshore funds, particularly the new swathe of European, global, US or Japan income funds.

The IMA said it still needs to see the details of whether or not funds will be exempt from tax on foreign dividends and if this would be an overall positive for investment vehicles.

Changes to the offshore funds’ regime is a further area being brought forward with planned changes and consultations in the new year. With the aim of achieving parity with onshore funds, changes could take tax considerations out of the equation for IFAs choosing between on and offshore vehicles. Under the current regime, it is still more attractive for investors to buy offshore bond funds and onshore equity funds from a tax point of view.

Julie Patterson, the IMA’s director, authorised funds & tax, said the announce-ments in the PBR and the forthcoming consultations show the Government’s commitment to enhance the competitiveness of UK-authorised funds.

“In isolation, each of these measures represents a specific technical change or changes but, when viewed as a package, they have the potential to reform the UK fund landscape,” she said.

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