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Schedule for change

Atax on UK funds could soon be abolished and while its impact may be small, it may lead to lower costs and a reduction in some fund charges. Vanguard has already indicated that it would adjust its up-front 0.5 per cent charge in line with whatever applicable changes are made to the UK’s schedule 19 stamp duty reserve tax regime.

In last month’s Budget, the Government said it intends to eliminate a portion of the schedule 19 tax, which only applies to UK-domiciled funds, and it would discuss further amendments. The IMA will be pushing to have the whole tax scrapped during these discussions.

Schedule 19 SDRT affects only UK-authorised funds and it is a complex and confusing area of fund taxation. Schedule 19 came about in 1999 to take into account dealing in unit trusts and Oeics. Fund managers pay stamp duty on the trade of the underlying UK shares but schedule 19 is about investors trading units or shares in the fund itself.

However, while there are two components to stamp duty in a fund, it is not considered a double tax. Together, the applicable tax should not exceed the headline rate of 50 basis points. In reality, even when both elements are combined, few funds ever incur a stamp duty charge that high.

Ever since its introduction, the industry has moaned about the presence of schedule 19 SDRT – not because it costs investors much but because the calculations and administration of SDRT is onerous, costly and nets very little for the Revenue. Under this regime, fund managers must calculate and pay SDRT on a monthly basis based on the value of surrenders in the fund, reduced by factors which take into account the number of units issued. Another reduction in the calculation is the proportion of assets in the fund which are not subject to SDRT, that is, foreign equities.

So annoying is this formula that many in the industry claim it costs more to work out what is owed than the amount paid. For example, in 2005/06, the Revenue reportedly took just £70m from SDRT across some 2,000 funds in the UK market.

But while cost and the small amount that schedule 19 brings in are the two main reasons that the industry has always pushed for its abolition, it is the competition angle which is now forcing movement.

IMA director of authorised funds and tax Julie Patterson says: “It is difficult to persuade continental European investors to invest in a UK fund in preference to funds elsewhere when UK funds pay a unique type of tax.”

The presence of schedule 19 is also creating difficulty for the UK to compete in the provision of master feeder structures, as allowed under the Ucits IV legislation. Again, this is a competition issue.

Ucits IV master feeder fund structures are considered to be a cheaper alternative to fund mergers. Under this structure, “feeder” funds in different domiciles could invest in the same “master” fund, allowing a single portfolio of assets to be offered in multiple jurisdictions and for different types of investors.

The UK is at a disadvantage in enabling such structures. Not only does it not have the legal framework in place but Vanguard head of retail Peter Robertson says schedule 19 SDRT could mean that non-UK assets are inadvertently taxed.

Other regions, such as Ireland and Luxemburg, already have the ability to offer master feeders and, with no added tax burden, they could become more attractive centres for funds to be domiciled.

According to Patterson, the more funds that choose to domicile here rather than offshore, the more business and employment taxes are received by the UK Exchequer.

The Government intends to set up a working group to consult with industry on whether to establish a tax-transparent contractual fund vehicle and says it will continue to work to refine the new regime for funds invested in non-reporting offshore funds. With a potential solution to that problem under way, it just leaves the tax considerations.

Typically, a consultation on any-thing to do with a tax change can take quite some time but due to the impending implementation of Ucits IV rules, a decision will have to be made sooner rather than later. Ucits IV must start be implemented by countries by next summer.

UK investors may not immediately notice if SDRT was eliminated. The payable fee is included within a fund’s transaction costs and the proportion of stamp duty, and the schedule 19 element, will vary from fund to fund. One of the most trans-parent application of SDRT is in the pricing of Vanguard’s passive funds because it places a 0.50 per cent fee outside to specifically cover investors’ applicable SDRT.

Robertson says the 50bps charge is a combination of schedule 19 and any stamp duty incurred when the fund has to purchase new shares as a direct result of the added inflow from the new investor. The fee does not cover the stamp duty within the fund when new purchases or sales have to be made as a result of index rebalancing.

Robertson says Vanguard is interested in the master feeder idea and as such it intends to take part in the consultations on SDRT. While he, like the rest of the industry, is hopeful for a broad ruling on the tax and maybe its abolition, he is not sure that it is likely. As schedule 19 was introduced to prevent any tax avoidance, the Revenue may look to keep some form of it going. Still, he says: “Obviously if the whole tax was removed or reduced, we would reduce our fee, which covers this tax, as well. How it would work will depends on what happens.”

It may be obscure and little known area of fund taxation for investors but for the industry the removal of schedule 19 SDRT would be celebrated and with lower costs incurred by companies in its calculation, it could only be hoped that it will be passed along to investors. Or at the very least it may free up costs, systems and time which could be better spent on other elements of fund manage-ment such as risk.


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