Real estate funds: The UK's other big deadline

New capital gains tax rules for foreign investors take effect in April. Richard Lowe reports 

March 29th is the deadline occupying most minds in the lead up to Brexit. But UK real estate investors and fund managers should be concerned with another three days later.

From April, foreign investors in UK commercial property will no longer be exempt from capital gains tax (CGT). When the government announced the plan in 2017 it raised questions about whether UK pension funds could also be caught if they invested through offshore funds, while also creating potential headaches for fund managers.

Two consultations have been broadly welcomed by the funds industry. The government confirmed in its Finance Bill in early November that it would implement a special regime for collective investment vehicles.

Christopher Austin, head of tax for private assets at Schroders and chair of Association of Real Estate Fund’s (AREF) tax committee says HMRC has listened to the “industry’s concerns” and implemented a practical solution. But, he admits, “there remain some practical issues to be resolved”.

John Forbes, a leading consultant on the subject, noted immediately after the Finance Bill that the proposals “address many of the concerns raised by the industry”, but fund managers “have a lot to do between now and April”.

One of the biggest problems could be the timing. The new CGT rules land immediately in the post-Brexit landscape and call for “market value rebasing” so that only future gains will be taxable.

It might prove to be a difficult time to value assets. Forbes imagines a scenario where appraisers are prompted to “caveat” their valuations due to market uncertainty. This last happened after the UK referendum in 2016, and played a part in redemption suspensions among open-ended property funds in the UK.

Ironically, efforts by the Financial Conduct Authority (FCA) to reform open-ended property funds could reinforce the problem. The FCA has published proposals including making it mandatory to suspend redemptions “when the independent valuer expresses uncertainty about the value”.

Another issue is that, although the government is targeting foreign investors, it risks catching tax-exempt domestic pension funds if they invest via offshore funds. To ensure UK pension funds are not hit with CGT, managers of offshore funds will have to either elect for tax-transparent status or special treatment. Funds will otherwise default to tax-opaque status, causing the funds and their investors to be liable for CGT. While these measures have been welcomed by the industry, potential problems could arise, especially around future changes of fund structures or changes in their investor mix.

“There are some complications for funds that are not plain, vanilla closed-ended funds,” says Forbes. “There is an election that can be made to treat the fund as transparent, but this is irrevocable. This election makes sense if the fund is closed-ended, but not if the fund subsequently converts to some form of open-ended vehicle.”

He adds: “There are also provisions in the legislation that are dependent on the percentage holdings of different types of investor. This is very difficult to control in an open-ended fund.”

The complications regarding offshore funds also raise the question of whether the UK government should introduce a new onshore vehicle that is less regulated than existing property authorised investment funds (PAIFs) and authorised collective schemes (ACSs), and can compete with offshore Jersey Property Unit Trusts (JPUTs) and Luxembourg fonds commun de placement (FCP).

Melville Rodrigues, partner at law firm Charles Russell Speechlys, says: “A key government policy driver is to create a level playing field from a tax perspective between UK and non-UK investors in UK real estate, and the final element was to extend taxation to all capital gains. Industry should look to persuade government to introduce legislation which also creates a level playing field at the real estate fund level.” What form this should take? “An onshore, lightly-regulated vehicle for a mix of institutional and professional investors equivalent to a JPUT or FCP and that would not be required to be open-ended”.

New corporate governance requirements

FCA releases guidance for independent directors. Melville Rodrigues

By 30 September 2019, managers of authorised open-ended UK funds must comply with new corporate governance requirements  of the Financial Conduct Authority (FCA), which call for a minimum of two independent directors on fund management boards (or similar ‘governing body’) – or, if the board has more than eight members, the independent directors must constitute at least 25% of the total board membership.  

These requirements apply to all funds irrespective of their assets under management. The requirements are being implemented alongside new rules on assessing and reporting on a fund’s value for money to investors.

The FCA wants management boards to balance investor interests with those of shareholders The FCA’s Market Study evidence indicates that management boards have been generally staffed exclusively by executives of the management houses, which it feels has led to weak competition. 

The FCA says the introduction of an independent perspective to support executive directors will lead to fund governance bodies focusing more on delivering value for money and better results for investors. 

Assuming that boards currently do not comply with the FCA’s new requirements, fund managers must begin to change board membership – and take steps to appoint the required number of independent directors. Managers might need to identify suitable candidates for independent director roles, as well as review the fund’s conflicts of interest and other corporate governance arrangements. Managers might also need to involve their investors in approving candidates. 

The FCA offers guidance for independent directors – for example, they need to have the experience and expertise to fulfil their role, although financial services expertise is not compulsory. They can serve a term of up to five years (renewed once to a maximum of 10 years and eligible for re-appointment after a further five years if they meet the other criteria) within one group. They can sit on more than one management board within a group.

The FCA reforms relate to managers of authorised open-ended UK funds only, though it will continue to consider whether to extend the governance proposals. The reforms more closely match the current mutual fund regulatory practice in the US, where the majority of directors are independent. 

The FCA reforms may lead investors to expect governance provisions in other funds – including those funds that are closed, unauthorised and structured outside the UK – to be harmonised with the FCA reforms and US practice. 

Melville Rodrigues is a partner at Charles Russell Speechlys  

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