For nearly two years the government has been conducting a review of the UK funds regime (the Review) with the aim of making the UK a more attractive location to set up, manage and administer funds and to support a wider range of more efficient investments better suited to investor needs. This review had already yielded some tangible results, in particular the recent introduction of the Long-Term Asset Fund (LTAF) and the development of the new tax regime for qualifying asset holding companies (QAHCs) which is due to come into force in April.
However, a key plank of the Review that has been progressing more slowly is a call for input (CFI) in which the government has been seeking stakeholder feedback on potential wide-ranging tax and regulatory reforms. The government received input from across the asset management sector, including from Travers Smith, and has now published a summary of responses to the CFI (the Response) in which it sets out the next steps on a variety of issues.
The three top priorities of respondents
The Response sets out the three areas most frequently cited as top priorities by respondents to the CFI and the government's plans in relation to them.
- The introduction of the LTAF as a new fund vehicle to support investor access to longer-term, less liquid assets. This was introduced in November 2021 but the Response confirms that ongoing work will be undertaken to facilitate rollout, including continued assessment of the case for further change to the tax rules and an FCA consultation on changing the restrictions on promotion of LTAFs to allow distribution to a wider range of retail investors.
- A review of the VAT treatment of fund management fees to ensure that it is internationally competitive, uncertainties or complexities are removed and the case for zero rating is considered. The Response confirms that the government will publish a consultation on this "in the coming months", however it will not consider zero-rating such fees. Zero rating is the gold standard for VAT treatment (as it allows suppliers to recover their own VAT without having to charge VAT to clients) and the Response indicates that the government did not feel applying it to fund management fees could be afforded in the current fiscal context. Although this approach is understandable, it leaves open the question of how (if at all) the government intends to address the anomaly, flagged by respondents (including ourselves), that the current VAT rules incentivise UK fund managers to use non-UK private funds rather than UK ones (broadly, because there is no VAT on supplies to the former as they are treated as taking place abroad but managers can recover their own related input VAT i.e. treatment akin to zero-rating applies). Indeed, more generally, some will be disappointed that the UK has not taken the opportunity (facilitated by Brexit) to give itself a competitive advantage compared with rival EU fund centres. This decision on zero-rating also has knock-on consequences in relation to the last of the three top priorities.
- Addressing gaps in the UK's current offering of fund structures for professional investors by creating an internationally attractive regime of onshore unauthorised professional investor fund structures which could be either closed- or open-ended. We now know that the government will work further to explore options for a new form of unauthorised fund in the form of a contractual scheme aimed at professional investors. However, the government does not believe there is currently a good case for introducing a new "light touch" form of authorisation for new unauthorised structures due to the potential for investor confusion as to their status. In addition, proposals for new unauthorised limited partnership and corporate fund vehicles will not be taken forward. The government's reason for this is that stakeholder feedback has indicated that such vehicles are unlikely to be commercially attractive if fund management fees are not zero-rated.
The Response contains news of various other proposals. Key points here include:
- The government acknowledged in the Response that it was keen to support the limited partnerships (LP) structure (particularly given its key role for private equity and venture capital firms) and to ensure that it works efficiently for investors. In light of this statement, the proposals are somewhat underwhelming. The government will not for the time being take forward any tax measures to address the decline in use of UK-domiciled LP funds, but says it welcomes engagement and further representations from stakeholders on the issue. The government intends to further consider non-tax issues relating to LP funds identified by respondents before taking forward any specific proposals for reform. A particular issue here that we raised, and which is specifically acknowledged in the Response, is the inability of English LPs to choose to have separate legal personality. The government also confirmed that it has recently reviewed LP legislation (which we assume is a reference to its 2018 consultation on reform of LP law and its 2020 consultation on corporate transparency and register reform) and intends to introduce measures to increase the level of (non-tax) transparency around the ownership and activities of LP structures. However, it did not provide any specific details of, or timeframe for, such measures.
- A review of the genuine diversity of ownership condition (GDO). The GDO is a condition that is increasingly being used in the UK tax code and which funds must satisfy to access certain tax benefits. It is designed to ensure that the fund is widely marketed and cannot be set up to give a limited number of investors a beneficial tax treatment. However, this can give rise to difficulties where a fund is held by a small group of institutional investors and uncertainty for widely held closed-ended funds.
- Further changes to the REIT rules will be considered by a new workstream. Some changes to the REIT rules, to improve the regime's attractiveness, have already arisen out of the Review and are due to come into force in April, but the CFI suggested further specific changes (for example, the removal of the requirement for a REIT to hold three properties). The workstream will consider those further changes plus wider suggestions and whether any of them should also apply to other fund types. In addition, the interaction of REITs with the new QAHC regime will be discussed. Any changes arising as a result of this workstream could happen quickly as the government will explore whether some of the reforms can be delivered in the next Finance Bill.
- The government will give further consideration to options to improve the tax efficiency of UK authorised funds. A particular aspect of this will be multi-asset/balanced funds as these can be tax inefficient, broadly, because they are liable to tax on interest income. In the CFI the government suggested several possible solutions. A couple of these now appear to be off the table (i.e. an extension of the "corporate streaming" rules to individuals and a low tax rate for authorised funds) but further thought will be given to giving funds a deemed deduction for distributions and/or introducing some form of optional tax exemption for them (see below). The CFI also queried why the uptake of the "Tax-Elected Fund" (TEF) regime, which was introduced in 2009 to remove tax drag in multi-assets funds, has been so low and whether anything could be done to address this. The Response acknowledges various stakeholder concerns with that regime and that respondents were not in favour of a solution which involves TEFs, but is not entirely clear whether this has been shelved. On a related point, the government acknowledged concerns with the current rules that, broadly, allow authorised funds with sufficient debt investments to make deductible interest distributions to investors (thereby increasing tax efficiency in the fund), and will consider making changes.
- The government will explore with stakeholders the case for an elective tax-exemption for authorised funds. However, the government has not considered tax exemption for unauthorised funds because the types of new unauthorised fund it is considering are tax transparent for income.
- An HM Treasury, HMRC and FCA working group will be established to progress work on permitting the distribution of capital by authorised funds. A significant number of respondents supported the principle of authorised funds being able to distribute sums out of capital on the basis that this would allow fund managers to develop new products that offer investors a long-term, sustainable, and predictable level of income (as capital could be paid out during periods with lower-yielding market conditions).
- As part of its ongoing double tax treaty (DTT) negotiation programme the government will consider various points raised by respondents in relation to how the UK's DTT network could be improved or enhanced for funds.
- The government does not intend to review the timeframes for fund authorisation and is not convinced of the merits of a "fast-track" authorisation process for professional-only AIFs. However, the FCA is considering how it can limit the number of questions that come up late in the authorisation process and, also, will engage with industry to explore what authorised fund managers would find helpful in terms of additional information regarding the application process.
- The FCA are considering what, if any, of the various proposals relating to Qualified Investor Schemes (QISs) they will take forward, however this appears to be on the back burner as the Response says that the FCA will take this forward "while taking into account their wider organisational priorities...". This may be because the government considers that many of the issues raised in respect of QIS have been addressed by the new LTAF structure. The government is also interested in the views it received on the benefits of having the statutory segregation of assets and liabilities between sub-funds extended to fund forms other than OEICs, but this will not be prioritised in the short term.
- The government says that, as it and the FCA are already pursuing policies that address the key points raised by respondents in relation to investment trusts (such as prospectus reform and the new Consumer Duty), there is no plan to take forward additional policy measures relating to investment trusts at this time. The Response also confirms that the government welcomes engagement with industry to enable it to further understand the difficulties related to the ongoing requirements that must be complied with to maintain HMRC approval as an investment trust.
- Further work with industry on the promotion of the UK's fund offering abroad. Although this is a helpful development, it falls short of our recommendation that there should be a permanent team in government responsible for monitoring and promoting the competitiveness of the asset management sector. It would be tasked with maintaining a holistic approach to private funds, so that there is a proportionate tax, legal and regulatory regime for them, and would have the ability to work (as one) with other departments to review changes which, in the round, could directly or indirectly adversely impact the sector and to veto adverse proposals. At present there is no single body in government with authority to deliver this.