Reserved Investor Fund consultation: tax

The government is consulting on the introduction of a Reserved Investor Fund (RIF) regime, which would take the form of a contractual scheme that may be marketed to professional investors and certain other sophisticated investors only. The consultation document published by HM Treasury, Reserved Investor Fund: Consultation, seeks feedback on a range of issues concerning the design of the proposed new fund, in particular the design of the tax regime for such a fund. The government references industry feedback that such a fund may be used mostly for real estate investment, although separately there has been significant interest generally in the creation of a broader tax exemption regime for onshore UK fund vehicles.

The consultation suggests that, due to concerns around the interaction between the RIF and the non-resident capital gains rules, the RIF regime may need to be restricted to certain scenarios that do not give rise to Exchequer risks, such as where all the investors are tax exempt, the RIF does not invest directly in UK property or in UK property rich companies, or where the RIF is UK property rich. These would be required to ensure that the regime does not allow non-resident investors to realise untaxed gains on UK property, contrary to the government's policy.

As an alternative, the consultation does consider the case for an unrestricted RIF, but with complex tax rules to address the risks identified by the government.

Background

Following Brexit, the government announced that it would carry out a review of the UK funds regime to consider reforms which would have the potential to enhance the UK's attractiveness as a location for asset management and fund domicile. Industry representations to the government suggested that there was a gap in the UK's existing funds range for a new UK contractual scheme that was open to professional and institutional investors, but not available to a broader retail investment market. Representations suggested that this new contractual scheme fund should be unauthorised and open to all asset classes, although it was expected to be particularly attractive to commercial real estate investors (given that such funds would likely be able to reclaim input VAT charged on management fees). The consultation seeks views on the potential scope and design of such a fund, to be called a 'Reserved Investor Fund (Contractual Scheme)'.

In particular, the government is seeking responses as to whether the government should introduce the RIF, and if so whether it should introduce an unrestricted RIF or a restricted RIF. In particular, the consultation invites views on:

• Restrictions to the investment strategy and/or eligible investors. Particularly whether the aims for a new unauthorised contractual scheme can be achieved if the RIF was restricted, either in relation to the assets the fund can invest in, or the type of investors permitted to invest in the fund

• The proposed design of a new tax regime for a RIF. It is intended that the tax regime should largely replicate the tax rules for Co-ownership Authorised Contractual Schemes (CoACS). In particular, the government is seeking views on the application of the non-resident capital gains rules to a RIF and options to overcome challenges identified with the non-resident capital gains tax rules.

Scope

The investors the RIF can be promoted to would be limited to professional investors, and certain other investor categories such as certified high net worth investors, certified sophisticated investors and self-certified sophisticated investors.

The government proposes that the RIF should be limited to co-ownership contractual schemes which meet certain eligibility criteria, including, as a minimum, requirements that a RIF:

• is 'UK-based' i.e. the operator and depositary must be bodies corporate incorporated in the UK, which administer their respective affairs in the United Kingdom; the operator and depositary must each have a place of business in the UK; and the deed setting out the arrangements which constitute the scheme is governed by the law of England and Wales, Scotland or Northern Ireland;
• is an Alternative Investment Fund;
• complies in substance with certain regulatory requirements imposed on authorised contractual schemes regarding the persons to whom units may be issued;
• meets either a general diversity of ownership condition or non-close test, in each case modelled on the version of the rules that apply for non-resident capital gains purposes; and
• has notified HMRC that it wishes to become a RIF and makes a declaration that it meets the above criteria.

The consultation notes that there was also industry demand similar unauthorised limited partnership and unauthorised corporate vehicle funds. However, since it was clear that that without a change in the VAT treatment of fund management fees, that the limited partnership and corporate vehicle versions of the RIF were commercially unviable, the government has not progressed work on these.

Tax regime

Industry stakeholders have suggested that the main use of a RIF would be holding real estate. Therefore, the consultation predominantly considers tax provisions that are relevant for RIF investment in real estate.

The government's objectives for the RIF tax regime are it should provide tax neutrality, such that an investor in a RIF will be in a broadly similar tax position as if they had invested in the underlying assets of the fund directly, and it will provide investors with certainty as to their tax treatment.

The government notes that industry stakeholders are largely in favour of replicating the tax rules that apply to CoACS for an unauthorised contractual scheme. Accordingly, the consultation explains that the intended tax regime will broadly follow that for the CoACS scheme. Since a RIF would be structured as a contractual arrangement, it would not be a taxable person for direct tax purposes and consequently, any income received by a RIF would arise directly to investors. The consultation also indicates that the RIF tax regime would broadly follow the CoACS scheme in relation to capital allowances, capital gains, reporting and SDLT, stamp duty and SDRT.

As regards VAT, this would apply to the management of RIFs as it does to the management of other funds. Accordingly, if an individual fund meets the conditions to qualify as a Special Investment Fund (SIF) for VAT purposes then the provision of management services would be exempt from VAT, otherwise it will be taxable.

Application of the non-resident capital gains (NRCG) rules to a RIF

However, the government has significant concerns around the interaction of the new RIF regime and the government's policy of taxing non-UK resident investors on disposals of UK property. If the capital gains tax rules for CoACS were to be replicated for RIFs without any further provisions, in some circumstances it would be possible for a gain to arise on disposal of UK property by a RIF without a non-UK resident investor being liable to tax on that gain.

In essence, the basic capital gains treatment for CoACS is to treat an investor's units as their capital gains asset and disregard any interest in the underlying property of the CoACS. This treatment is modified for NRCG, so that units in a CoACS are treated as shares in a company for the purposes of determining whether an investor has an interest in a 'UK property rich' company. Indirect disposals are subject to NRCG where an interest is held in a 'UK property rich' company. If the capital gains tax rules for CoACS were to be replicated for RIFs without any further provisions, it would be possible for a gain to arise on disposal of UK property by a RIF without a non-UK resident investor being liable to tax on that gain where the RIF derived less than 75% of the value of its total assets from UK property, as there would be no tax at RIF level and a non-UK resident investor would not be taxed on a disposal of their RIF units where the RIF itself was not UK property rich.

The government stresses that any RIF tax regime would need specific rules to address that issue, but those tax provisions are likely to be complex. Therefore, the government is considering the case for introducing a 'restricted' RIF. A 'restricted' RIF would only be available in circumstances where there is no risk of loss of tax from non-UK resident investors on disposals of UK property, and in those circumstances the CoACS simplified capital gains rules could be adopted.

A restricted RIF

A restricted RIF would be restricted in terms of its investor base and/or the assets it can invest in, such that there is no risk of loss of tax from non-UK resident investors on disposals of UK property. Current restrictions being considered are that the RIF regime would only be available:

• where at least 75% of the value of the RIF's assets is derived from UK property (so the RIF is 'UK property rich' for the purposes of the NRCG rules); or
• where all investors in the fund are exempt from tax on gains (for example, certain pension funds); or
• where the fund does not directly invest in UK property, or in UK property rich companies, with the possible exception of minor interests in UK property rich collective investment vehicles.

Where a restricted RIF breached the restrictions (for example, a UK property rich RIF that had been a restricted RIF as a result becoming non-UK property rich) then the government suggests that the RIF would become tax transparent for gains permanently. Transparency for capital gains would have the effect that gains on direct and indirect disposals of UK property would arise to all (UK resident and non-UK resident) investors and they would be within the charge to tax on their share of relevant gains made on disposals of UK property. In this circumstance it is expected the legislation would deem a RIF to be a partnership for gains to ensure that there is certainty on the basis on which gains would be computed.  It is unclear whether this would result in additional compliance burdens for the RIF, such as the obligation to file a UK partnership tax return as well as providing relevant information to investors.

In addition, where a restricted RIF which was UK property rich ceased to meet any of the restrictions, the government's proposal is that there would be a deemed disposal and reacquisition of an investor's units in the RIF immediately before the RIF ceased to meet those restrictions to ensure all untaxed gains (whether or not derived from underlying UK property) during the period in which the RIF was restricted do not escape the UK tax net.

The consultation does indicate, however, that a mechanism for minor and temporary breaches of the UK property rich requirement may be included. However, to remove risks to the Exchequer, any grace period would have to be temporary, and it would need to include a condition that no disposals of UK property took place in that period.

Similar provisions would be needed to deal with breaches of restrictions by restricted RIFs based on the exempt investors head and the no investments in UK property head.

An unrestricted RIF?

Despite the concerns over the risks posed to the UK Exchequer of an unrestricted RIF, the consultation does consider the possibility of introducing such a fund, but with the protection of additional, complex tax provisions based on two options:

• Transparency for gains only at the point of a disposal of UK property, or a change in the RIF's investor base
• Transparency for gains for the period a RIF is non-UK property rich.

The first option would be to treat the investors' units in the non-UK property rich RIF as their capital gains asset and disregard their interest in the underlying property of the RIF, except at the point where there was a disposal of UK property, or where there was a change in the RIF's investor base. This would ensure gains on disposal of UK property were liable to tax for non-UK resident investors, as gains on disposal of UK property would arise directly to investors in the RIF. However, computations of gains on disposal of UK property are likely to be complex, particularly in respect of determining an investor's base cost in the UK property assets. It is expected that the tax rules would need to specify that the operator of the RIF would have the responsibility for providing investors with sufficient information to meet their UK tax liabilities.

The second option would be to treat the investors' units in a non-UK property rich RIF as their capital gains asset and disregard their interest in the underlying property of the RIF, except throughout the period the RIF is non-UK property rich. This would ensure gains on disposal of UK property were liable to tax for non-UK resident investors. For this option, it is intended that transparency for gains would apply to disposals of all assets during the non-UK property rich period. It would be necessary for there to be a deemed disposal and reacquisition of investors' units in a RIF, where the RIF transitions between UK property rich and non-UK property rich. Such a deemed disposal and reacquisition would lead to dry tax charges (where a tax charge arises but no cash has been distributed to investors by the RIF to pay that tax charge), though the government may consider introducing provisions for deferral of the point at which tax on gains is payable to address this. As with the first option, the government expects that complex computations would be required to calculate gains on disposal of the underlying UK property, particularly in respect of determining an investor's base cost in the UK property asset(s), as an investor's base cost is otherwise in respect of their units in the RIF.

Reporting

To align with the reporting obligations for a non-UK collective investment vehicle, the government intends to include provisions that require the operator of a RIF to annually report disposals of UK land and details of the investors in a RIF to HMRC.

Comments

The consultation closes on 9 June 2023 and comments should be sent to UKfundsreview@hmtreasury.gov.uk. This is a short period for feedback, although the measures have been discussed in some detail with relevant industry working groups. We will be responding to the consultation, and are happy to collate and reflect feedback on the measures as appropriate.