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Yielding to the inevitable

Investors in property, equity income and fixed-interest funds are finally going to have an easier time telling the difference between the income levels of the funds on offer. A number of different industry initiatives are coming together in the next few months that could lead to greater transparency and understanding of income distributions by funds and in some cases may also lead to greater payouts.

At the end of July, the Treasury is set to publish a consultation paper into the treatment of rental income within property funds. The paper, which should be finalised and implemented by April 2008, will specifically address the taxation of rental income and how it currently differs from UK real estate investment trust rules, creating what industry members feel is an unlevel playing field.

The Investment Management Association commissioned a report from KPMG on taxation within authorised funds last year, which touched on the issue of property funds as well. The IMA is in discussions with the Treasury to take forward proposals contained in this report.

As it currently stands, rental income in Reits is paid gross and taxed in the hands of the investor but within an authorised fund it is taxed at 20 per cent due to the corporate tax paid by collectives.

The forthcoming draft rules therefore appear straightforward and will look to address ways in which rental income within a fund structure can be distributed gross, separate from dividend or interest distributions, in a manner similar to Reits. This will mean an immediate boost to any investor within a property fund although whether or not further tax is owed on the distribution will depend on the individual investor’s tax position.

This sounds positive in theory but there is a lot of work to be done before investors see any substantial change, even if the Government manages to stick to its April deadline. For one, the finer points of the Government’s suggestions are likely to be debated, no matter how favourable they may appear to be on the surface.

For providers of property funds to strip out rental income distributions will require a hefty systems change for many. At the same time, due to differences between company and trust law and other technicalities involved in such a tax switch, it is likely that property unit trusts will have to be converted to Oeics to benefit from any rule change. Most existing authorised property funds are unit trusts.

Coming sooner than changes to property funds will be greater transparency and disclosure of the income payouts from equity income funds – an area of much heated debate as the popularity of these vehicles continues to grow. At the moment, fund providers publish and advertise their income funds using a yield figure which can be calculated in any number of ways.

Yields are typically presented as a forecasted figure and can differ significantly from what the investor ends up with as a payout. Such is the lack of comparability of fund yields that it has become virtually impossible for an investor or adviser to differentiate between funds that are sacrificing income for higher capital gains and those seeking to provide a steady rising dividend.

This makes giving advice on equity income fund selection exceedingly difficult but now the IMA is close to finalising an industry standard which it hopes will become a best practice solution to the presentation of yield information.

Under this guidance, which it is hoped will start to be used by the autumn, providers will show the yield on a historic basis – the actual paid or declared distributions from the fund over the 12 months prior to the publication of the figure. This seems easy enough so it is a wonder that it has taken the industry years to come up with such a solution.

Publishing fund yields has always been a sensitive issue, however. After all, it may not flatter some when they are compared with others and a lot of funds are sold on their headline yields.

As this standard is unlikely to become mandatory, providers may continue to use forecasted figures but included in the guidance is expected to be a requirement that if forecasted yields are used, the provider must explain why as well as explain any difference between that and the historic yield. The difference may just be wide enough that explaining why may be more detrimental to the sale of a fund than publishing a somewhat lower headline yield than that on offer from competitors. Hopefully, industry peer pressure will lead to significant changes and transparency for end clients, which will go a long way to making advisers’ jobs easier.

This is not the first time that fund yields have caused a problem, nor the first time the industry itself has tried to develop a solution. Eight years ago, the IMA, then called Autif, finalised a standard calculation on bond yields, which was never fully implemented despite the amount of work it entailed and consensus within the industry that was reached.

This is because the FSA got involved, according to some in the industry. Whether or not the FSA will be involved in this initiative and, if so, to what degree, has yet to be decided.

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