Finance and Tax Blog for individuals and companies

Our previous briefing on property authorised investment funds (PAIFs) outlined some of the legal and commercial obstacles preventing a successfully launch of such investment fund vehicles. There is another major commercial issue around capital seeding of new PAIFs. Broadly, the tax rules state that PAIFs must have at least 60% of their assets in eligible property assets which include ownership of Commercial Property, Shares in Real Estate Investment Trusts (REITs) and certain offshore funds with similar attributes.

A number of property fund managers have funds based offshore in Jersey or Guernsey Channel Islands commonly known as JPUTs or GPUTs. Historically theses funds had been set up to enable managers to co-mingle onshore UK approved pension funds and overseas investors without tax sticking at the fund level. Where such funds wanted to attract UK SIPP investors a listing of the fund units on the Channel Islands Stock Exchange (CISX) broadly such funds had been structured as tax look through for income such that any UK tax attributable to net rental income could be recovered by UK tax exempt investors. The onshore equivalent to these funds was Exempt Unauthorised Units Trusts (EPUTs).

A way to tackle this seed capital issue would be to bring JPUTs or GPUTs onshore as first UK authorised unit trusts followed by a conversion to PAIFs. In general there are a number of UK tax breaks to facilitate this process with the exception of an immediate relief for Stamp Duty Land Tax (SDLT) on the first step of the migration process. Potentially SDLT at the rate of 4% on the underlying property portfolio could be triggered on migration of the PUTs onshore. However, there are legal aspects which could be addressed to mitigate this problem. Careful drafting of the PUTs trust deed of variation and changes to appointment of UK Trustees and retirement of offshore trustees could prove helpful to the fact pattern.

In addition to SDLT above there is a cash flow position to manage on UK VAT since for VAT purposes the first and succeeding steps in the on shoring process triggers a change of ownership. Again this matter can be addressed by careful planning. Government authorities are aware of these matters and are usually helpful in accommodating a commercial project plan.

During the last 5 years or so the UK Government has introduced a number of welcome initiatives to promote the UK as a Fund domicile of choice. To their credit they have engaged in extensive consultation with the Funds’ industry to meet its objectives.

Apart from the apparent success of the UK reporting fund regime (judged by number of new funds that have recently joined ). Why have some initiatives not succeeded so far?

In the first of these briefings we look at Property Authorised Investment Funds (PAIFs).

PAIFs had been introduced to cater for industry demands for an onshore equivalent of offshore property unit trusts e.g. JPUTs. Prior to their introduction tax stuck within a UK property fund for exempt UK pension funds including SIPPs and ISAs: Why? Because such investors could not obtain repayment of the UK tax credit on distributions paid out of net rental income subject to UK tax at 21%. Notwithstanding rectifying this potential tax leakage PAIFs are slow to gain momentum.

Clearly the economic downturn in property asset class where most fund managers were grappling with redemptions and management of liquidity has been a significant reason. There are, however, other issues:

First, the tax withholding treatment of net rental income paid to non-UK investors. This WHT can be reduced under applicable tax treaties with the UK. But in the case of an overseas exempt investor this can lead to a final tax and means they are not on par with UK exempt investors. In the case of an overseas investor subject to tax the amount withheld can be in most cases be set against local tax. It is difficult therefore to market an offering to both UK and overseas investors who want UK commercial property exposure.

Secondly, the tax avoidance measure on corporate investor holdings of 10% or more. HMRC have helpfully allowed a carve out from this rule enabling a corporate investor to structure their holding through a UK authorised unit trust but commercially this gives compatibility issues for a number of investors including fund supermarkets. While in the latter case we understand market developments are being taken forward to combat this obstacle to effective marketing it has nevertheless a 12-18 months lag on new possible launches.