Melville Rodrigues, Senior Consultant - Fund Services, who is leading the initiative for the Professional Investor Fund (PIF) - a new fund proposal for the UK funds industry - provides an overview of the proposal and outlines his hopes for the next steps of the initiative.
In its Spring 2020 Budget, the government stated that it will ‘undertake a review of the UK’s funds regime during 2020. This will cover direct and indirect tax, as well as relevant areas of regulation, with a view to considering the case for policy changes’.
Those involved in lobbying for the PIF welcome this statement. We feel there is a gap in the UK’s fund offering for professional investors in order to give greater choice alongside other international options. In particular, fund management houses looking for a closed-ended or hybrid fund to hold UK real estate investments (which have the attributes of being unlisted, tax transparent and offering tradeable units) have limited choices for a UK domestic structure. Their onshore fund choice (with these attributes) is restricted to an open-ended authorised fund. An open-ended fund must comply with operational requirements that erode returns and may be inappropriate for holding illiquid assets.
Representatives of HM Treasury and the Financial Conduct Authority (FCA) have constructively engaged with the PIF initiative. Details of the PIF proposal are contained in the Submission Document of the Association of Real Estate Funds (AREF), and the proposal is supported by the Investment Association (IA). The IA has incorporated the PIF within the framework set out by the UK Funds Regime Working Group. Under this framework, the IA suggests the creation of a new Onshore Professional Regime, in which the PIF would play an important role.
How will a PIF be structured?
The PIF is modelled on the Authorised Contractual Scheme (ACS) legislation, with appropriate revisions flowing from the PIF not being an authorised fund. For the purposes of the (current) UK regulatory regime, the PIF would be an Alternative Investment Fund (AIF) and an Unregulated Collective Investment Scheme (UCIS).
It is envisaged that the PIF will be formed by contract—formalised as a deed (PIF Deed)—initially made between the PIF's Alternative Investment Fund Manager (AIFM) and depositary (Depositary). On admission, investors in the PIF (Investors) would become parties to the PIF Deed. The legal title to the assets would be held on behalf of the Investors, and the Investors would be jointly the beneficial owners of the PIF's assets. The beneficial title in the assets will be held as tenants in common under English law, or in Scotland as common property. The AIFM would make decisions on behalf of the Investors about the acquisition, management and disposal of the assets as well as risk management, subject to provisions within the PIF Deed, and those decisions would be binding on the Investors.
For practical purposes, I envisage that—as the PIF does not have a separate legal personality (like an English Limited Partnership (ELP) and ACS))—equivalent solutions for holding the legal title of assets will be adopted for the PIF as in the case of the ELP and the ACS. These solutions will need to take into account the regulatory responsibilities of the AIFM and Depositary. For instance, the PIF may need to hold:
- real estate in England and Wales via two nominee companies (and one in Scotland) that is companies holding the asset on trust for the benefit of Investors
- listed securities and other financial instruments, via a custodian
There will be relevant regulatory controls for the AIFM and Depositary.
What regulatory issues need to be addressed?
The PIF proposal suggests that key regulatory issues are addressed by the PIF:
- investor status - Having the same category of investors as are permitted to invest in a Qualified Investor Scheme ACS. For example, direct investment in a PIF would be restricted to investors who invest a minimum of £1m and are professional investors. Other investors can only access the PIF through feeder funds that satisfy the professional investor status.
- fund status - Being an AIF for the purposes of the Alternative Investment Fund Managers Directive, managed by an AIFM, and having a Depositary. In the case of listed securities and other financial instruments, the Depositary appoints a custodian
- marketing - Being a UCIS for UK regulatory purposes, which means being marketed under the UCIS regime, and
- registration - Being established and operated via a registration of the PIF and its Investors at a registry (PIF Registry) similar to that which applies in the case of a UK Limited Partnership. The AIFM will be required to register with the PIF Registry details about the PIF including its principal place of business, Investors and any changes in the Investors. I envisage that the PIF Registry will be administered by Companies House, and Companies House will issue on completion of the registration process a PIF Certificate of Registration. The PIF Certificate of Registration will be conclusive evidence that the PIF came into existence on the date of its registration—equivalent to section 8C of the Limited Partnerships Act 1907 (as amended)). It is envisaged that certain information at the PIF Registry (such as its principal place of business) will be publicly available. However, other information (such as details of the Investors) will only be available to HMRC and the FCA, respectively for registration, tax collection issues and addressing concerns about harms/risks
How will the PIF be treated for tax purposes?
The tax proposals for the PIF follow that of a co-ownership ACS, modified on account of the PIF not being an authorised fund. As the PIF will not have its own legal personality, it will not be within the charge to direct tax. The PIF will be tax transparent with tax liability applying to the Investors:
Income and capital gains
- income will be taxed on the share attributable to each Investor
- capital gains will be taxed on each Investor disposing its PIF units, but not on gains realised at the PIF portfolio level
In the case of non-UK investors, the fiscal transparency of the PIF means that it will not be treated as resident for the purposes of double taxation conventions. Assuming that the overseas jurisdiction recognises the PIF as a transparent entity, Investors should be entitled to the same treaty benefits as though they had made the PIF's investments directly. Where the PIF meets the non-resident Capital Gains Tax (CGT) property richness condition, non-resident Investors will be subject to non-resident CGT legislation.
The Stamp Duty proposals for the PIF are modelled on the provisions that apply to the ACSâ€”for instance, in the case of PIFs holding UK real estate:
- no transaction tax (including Stamp Duty Land Tax (SDLT) would apply on the transfer of units in a PIF
- as is the case with the co-ownership ACS and Property Authorised Investment Funds (PAIFs), SDLT seeding relief applies to the PIF. This will assist in launching new PIF projects with a similar clawback mechanism as applies for co-ownership ACSs and PAIFs to limit the scope for tax avoidance
The government helpfully announced in the Spring 2020 Budget that it will undertake a review to consider the VAT treatment of fund management fees. I hope that this treatment will take into account the PIF.
The PIF proposal contains suggested tax anti-avoidance rules to prevent PIFs being used in a way which is not intended. The proposal also suggests that further technical points are addressed through working groups in government and industry—for instance, the treatment of holdings of PIF units for inheritance tax purposes or in addressing other avoidance issues.
Next steps for the PIF initiative
Many UK fund management houses support the PIF. As and when any PIF legislation is enacted, fund management houses will be able to utilise the PIF as an onshore fund structure to pursue real estate, infrastructure and other investment strategies related to the UK and elsewhere. In addition, the PIF is designed to be attractive to domestic as well as to international pension funds and other institutional investors.
The PIF will reduce barriers for new funds, and enhance the UK’s brand for fund and asset management. The PIF will also enable the fund management houses to facilitate the UK government’s goals for coronavirus (COVID-19) reconstruction, infrastructure revolution and ‘levelling up’ the nation, as well as to respond to the opportunities presented by Brexit.
I hope that the government progresses its review of the UK’s funds regime with a consultation that considers the gap with the current UK fund offering, and the merits of legislating for the PIF to address the gap.
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* Article first featured on Lexis Nexis on 13/05/2020