We explore the proposal from the Association of Real Estate Funds (AREF), for a new form of onshore fund, the Professional Investors Fund (PIF), as a new fund vehicle for professional investors in real estate.
The UK asset management sector is the largest in Europe and makes an invaluable contribution to the UK economy. The government has recognised the contribution it makes and has been pro-active in establishing an Asset Management Taskforce to work with the regulator and industry. Last year the government commissioned a report by the Investment Association on the future of travel for the sector to ensure that the UK's regime remains competitive and the Investment Association has recently updated its report to incorporate the PIF proposal.
The UK government published a consultation which recently closed on the tax treatment of asset holding companies in alternative fund structures. The consultation explores the attractiveness of the UK as a location for intermediate entities through which alternative funds hold assets. It is one step in a larger review of the UK funds regime, focusing on taxation and regulation, which was announced in the Spring Budget 2020. Another part of the review, looking at the VAT treatment of fund management fees, is also expected later this year.
What is the proposal?
AREF has proposed the PIF - a fund vehicle in the form of an unauthorised contractual scheme which would be unlisted, tax transparent, have tradeable units and would not itself be required (nor permitted) to be authorised for UK regulatory purposes.
Why has it been proposed?
The PIF aims to offer an onshore alternative to current offshore structures used to hold UK real estate. At present there are barriers to the establishment of such intermediate fund vehicles in the UK especially in relation to regulatory requirements and transfer taxes.
As AREF highlight in its report, UK fund managers are currently forced to consider other jurisdictions if they want to serve institutional investors with a closed-ended, unlisted, tax transparent fund with tradeable units (being units not inhibited by transaction taxes) because, at present, the UK does not offer an equivalent fund vehicle. As AREF notes, this often leads to additional operational costs and the challenges of multiple layers of legal, tax and regulatory regimes.
What are the potential benefits of the PIF?
The operational costs and risks of running an offshore fund would be eliminated if the managers, investors and underlying real estate were all UK based. A wholly UK based fund would also avoid other legal and regulatory costs in maintaining sufficient substance requirements offshore.
The AREF proposal also cites the UK's world-class regulatory regime as a benefit of the PIF, suggesting that trustees and other fiduciaries of institutional funds would prefer the corporate governance and other investor protections which apply to commitments via funds and managers regulated by the FCA. AREF also comment that non-UK pension and other institutional funds would also value the benefit of such protections.
If successful, the PIF could be expanded to other asset classes, therefore increasing the attractiveness of the UK for other type of funds.
What are the potential challenges facing the PIF?
There are various challenges facing the PIF, such as how HMRC would approach the application of Stamp Duty Land Tax (SDLT) to the structure. There are often SDLT savings from using other jurisdictions for real estate funds (for example Jersey property unit trusts are common holding vehicles as the units in the trust can be sold without SDLT being due). Would the government propose a similar type of regime for the transfer of units in a PIF?
The AREF proposal suggests that SDLT will not apply on transfers of units in a PIF (using the same framework which applies to Authorised Contractual Schemes) – commenting that if the PIF were deemed to be a property investment partnership, it is unlikely that it would provide an attractive onshore option. There would arguably be no loss of revenue when compared against the current offshore structures. How palatable this is may depend on any wider government strategy on the scope of SDLT. Some fear that the government could, in the future, seek to widen the rules to levy SDLT on the sale of interests in property rich entities.
As the PIF would present investors with an alternative option of investing in the UK, how would this impact on other jurisdictions which are typically chosen for funds - for example would the government feel the pressure to not materially prejudice the Jersey fund industry?
Brexit has presented many challenges for the UK funds industry and there is still uncertainty over whether UK fund managers will be able to rely on their AIFMD marketing passport after 2020. Whilst the PIF may be attractive for UK investors it will be for each EU member state to consider whether to allow it to be marketed or sold to professional investors in their own jurisdiction. Many fund management houses have taken steps to ensure they have substance in an EU jurisdiction and so may continue to use, for example, a Luxembourg structure to ensure access to the European market.
Although the PIF is still at an early stage, it is hoped that the government will consider the proposals as part of its ongoing review of funds. Any proposal to strengthen the UK's asset management sector must surely be one worth seriously considering.
This article first appeared in Estates Gazette online on 29 September 2020.