Tom Squire and Martin Connolly discuss how new legislation is making the UK a more attractive domicile for UCITS funds.
HM Treasury has taken steps to further improve the attractiveness of the UK as a domicile for undertakings for collective investment in transferable securities (UCITS) funds. A consultation has been announced with a view to launching an authorised UK tax transparent fund (TTF) vehicle. Draft regulations for consultation are expected by late 2011 with secondary legislation implementing the regime expected by summer 2012.
The UK has typically not been the domicile of choice for UCITS funds, with the market standard being either Ireland or Luxembourg. The UK does have several attractive characteristics as a domicile for UCITS funds due to its robust regulatory process and extensive network of double tax treaties. However, these are often outweighed by factors such as the speed at which a fund can be launched and the perceived certainty and stability of the tax and regulatory environment offered by other jurisdictions.
The lack of a true TTF vehicle has also been one of the key areas where the UK has lagged behind. Competitor jurisdictions such as Ireland and Luxembourg have tax transparent vehicles such as the Common Contractual Fund and Communs de Placement respectively.
While the UK does offer a variety of legal structures for investment pooling, such as unit trusts, open-ended investment companies and investment trusts, it does not offer a true TTF vehicle to compete with Ireland and Luxembourg. Currently, only a number of pseudo-TTF vehicles, such as property authorised investment funds and tax elected funds, exist.
The lack of true tax transparency introduces an additional layer of taxation at the fund level, increasing the effective tax burden on investors due to withholding taxes being applied without regard to the underlying investor type or domicile, directly reducing fund performance and investor returns.
Non-TTFs are not tax neutral and introduce a cost to investing via a fund rather than investing directly. Fund managers often cite being able to achieve tax neutrality in the fund structure as a key consideration when selecting a fund domicile.
The implementation of UCITS IV into UK law from 1 July 2011, allowing for pan- European master-feeder UCITS structures, has provided the necessary spur for reform and the establishment of a truly tax transparent UK fund vehicle. A UK TTF would enable investors to pool their assets cross-border in a fund to obtain economies of scale without losing any withholding tax benefits associated with their country of domicile, i.e. achieve tax neutrality at fund level. This puts UK master funds on the same footing as those domiciled in offshore centres, which should attract the establishment of new master funds in the UK, particularly as fund managers seek to rationalise and restructure their fund ranges in response to the opportunities afforded under UCITS IV.
UCITS IV also introduces several other changes which should provide opportunities for the UK fund management industry, such as the European-wide passport for investment management companies which will allow UK management companies to manage non-UK domiciled UCITS funds. UCITS IV also facilitates the cross-border merger of UCITS funds from a regulatory perspective, although much remains to be done in other jurisdictions to make cross-border mergers viable from a tax perspective.
Investor demand for tax transparency also looks set to grow as the result of initiatives (such as the US Foreign Account Tax Compliance Act) which emphasise the transparency of holdings and the political pressure to move away from lightly regulated offshore centres driving the need for a UK TTF to maintain competitiveness.
Without the introduction of a TTF vehicle, the UK would risk losing funds under management and the associated jobs and economic contribution to other jurisdictions, a risk HM Treasury can ill afford in the current economic climate. A UK TTF would improve the UK's ability to compete as a fund domicile but there remains much more to be done in order to make the UK the domicile of choice for fund managers. For instance, while the Finance Act 2011 exempted investments made by funds in other funds from SDRT with effect from 20 July 2011 (subject to certain conditions), the failure to abolish SDRT Schedule 19 in its entirety has proved disappointing and continues to be an impediment to the competitiveness of the UK fund management industry.
Despite this, there remains an ongoing and constructive dialogue between the UK Government and industry figures to bring about the necessary changes to improve the UK fund management industry's competitiveness, attract new funds and eventually become the domicile of choice.
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