Should SDLT rules for property investment funds be reviewed?

Cathryn Vanderspar , a tax partner at Berwin Leighton Paisner LLP, examines the government's case for making changes to the stamp duty land tax (SDLT) rules for property authorised investment funds and co-ownership authorised contractual schemes and the potential design of those changes proposed in the consultation on SDLT  rules for property investment funds.

What are the problems with how SDLT is applied to property investment funds?

The design features, including anti-avoidance measures, are the focus of this consultation, with the deadline for responses being 12 September 2014. The consultation addresses SDLT issues with two types of funds.

The problem identified with PAIFs is that the existing seeding relief revolves around the transferor vehicle being an authorised unit trust scheme. It does not apply to the seeding of PAIFs with assets from other structures, such as life insurance companies and pension funds, which managers would like to collectivise and modernise. Without an express relief, there could, therefore, on seeding, be a charge to SDLT in the fund on the value of the entire portfolio, even if there is no change of ultimate beneficial ownership. This means that seeding using the PAIF in these circumstances is economically unviable.

The issue with CoACSs is that the government has not previously expressed any opinion at all on how it should be treated for SDLT. This has created uncertainty, but as a form of co-ownership, strictly, there could be SDLT charges at investor level each time there is a change of ownership in the fund. This is clearly commercially unattractive for investors compared to alternative structures.

For the funds industry, a further issue is, however, that the government has not yet decided whether a sufficient case has been made for introducing the further SDLT reliefs contemplated in the document. The consultation, therefore, seeks more quantitative data on the need for change, as well as putting forward technical proposals for consultation. This continues uncertainty and timing issues.

How damaging to the uptake of PAIFs and CoACS are these problems?

Many UK managers are keen to use the PAIF and CoACS as new UK property fund vehicles and we have now seen several well-known major players, as well as new players, enter the sector.

Managers are, however, effectively prevented from further seeding the new vehicles, due to these SDLT issues and have to continue to consider other fund alternatives. This is not helpful to the creation of a large and thriving PAIF sector, with the brand creation and market recognition that should come with it.

Seeding relief from SDLT for unit trusts led to certain tax planning structures, how would this be dealt with under the new proposed seeding relief for PAIFs?

The previous seeding relief for unit trust schemes had very few restrictions. The current proposal is very different--even as a starting point the PAIF must be authorised by the Financial Conduct Authority (Fca) and be able to satisfy other tests, such as diversification and 'genuine diversity of ownership'.

In addition, the government proposes:

  • limiting the relief to the initial seeding of the PAIF
  • requiring the only consideration to be the issue of new units
  • introducing a 'portfolio' test with a minimum number of properties of a certain value--the current proposed minimum is 10 properties for commercial property and 100 for residential (there is no suggestion as yet what the individual value should be)
  • having a minimal size for the seeded portfolio of £100m
  • possibly introducing further restrictions if residential property is let to a connected person
  • a general anti-avoidance test, and
  • a clawback of the SDLT saved, taxable on the seller, if either PAIF status is lost and/or there are any disposals of the seller's interest within three years

There is some debate that the portfolio threshold levels proposed are too high and as to precisely how the number of properties required would be arrived at in certain scenarios--for example, would a shopping centre be one property or be considered on a unit basis (as in a real estate investment trust (REIT)) or otherwise?

A more major practical issue is, however, likely to be around the operation of the clawback for certain types of sellers, such as life insurance companies or pension funds, who may need to make redemptions to meet obligations to policy holders. This could trigger the very SDLT charges that the seeding relief proposal is seeking to avoid. Helpfully, on the other hand, the clawback should not be triggered on dilution of interests when new investors enter the fund and, as the clawback would be on the seller, it should avoid issues (such as pricing) for investors generally. It is contemplated that the clawback could be proportional to the disposal and with a de minimis, and this point needs to be reinforced.

What are the proposals in relation to CoACSs?

The proposals in relation to the CoACSs are different, due to the transparent nature of the vehicle. The government has decided that CoACSs should not be treated like a company for SDLT purposes. Accordingly, the suggestion is:

  •  to ensure that there is no SDLT on issue, redemption or transfer of units (which is excellent)
  • to provide that the operator will be treated as the purchaser in relation to the fund
  • to have a prima facie market value charge on transfer of property to the CoACS from connected persons or unit holders, unless the CoACS fulfils criteria similar to those for a PAIF for seeding relief, and
  • to include any other express conditions, thought necessary, such as the inclusion of an express genuine diversity of ownership test

Sub-funds would be treated separately (and some clarity is needed around how the portfolio thresholds would operate in this case) and rules would be introduced around the identification of the seller, for the purposes of determining whether group relief or treatment as a linked transaction are relevant on disposals.

Would the proposals outlined in the consultation document remove the barriers to the use of CoACSs and PAIFs?

The proposals should remove much of the current barrier to more widespread use of each of the PAIF and CoACS. Fund managers, however, also still want to resolve the streaming issue with the PAIF at the platform level, so that the PAIF can operate more efficiently generally, as originally intended.

Are there any unintended results of the proposals?

The main issue is likely to be for the seller in needing to have sufficient compliance procedures in place to be able to monitor holding the property for the three-year period, to minimise clawbacks, and to meet any other ongoing (say certification) requirements. Given the benefits, however, subject to a satisfactory solution to the clawback mechanism, these aspects are likely to be manageable.

Do you expect the uptake of UK PAIFs and CoACSs to take off now?

The funds industry is working with HMRC through the consultation process to ensure that the changes optimise the chances of these vehicles being used and that they are suitable for purpose for the main protagonists also on a practical level.

These vehicles offer up to date, UK tax efficient structures, open to a wide range of local and international investors, both retail and institutional. With umbrella structures being available, they also offer the benefit of cost efficiencies.

We know that clients are keen to use them.

How does this compare with the REIT regime?

The government is not currently considering introducing a seeding relief for REITs or other structures. As a closed-ended structure, the solutions to the issues involved for REITs would be different.

Cathryn Vanderspar has over 20 years of tax experience. She specialises in real estate as an asset class and funds taxation. She is author of the chapter on REITs in Tolley's Taxation of Collective Investment. 

Interviewed by Kate Beaumont. The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

Filed Under: Property

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