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Investment company
technical release
March 2012

Revised tax regime for investment trust companies

Introduction
HMRC’s regulations on the modernisation of the tax rules          company the benefit of the results of the management of
for Investment Trust Companies (ITCs) were approved by            its funds.
Parliament in December 2011 and the new regime is effective           Condition B – that the company’s ordinary shares must be
for all accounting periods commencing on or after                 admitted to trading on a regulated market.
1 January 2012.                                                       Condition C – that the company is not a Venture Capital
   As an increasing number of investment companies have           Trust or a UK Real Estate Investment Trust.
chosen to establish themselves offshore in recent years,              These new eligibility conditions largely do away with the
HMRC hopes that a more principles based regime with               15% holdings test and the 70% income test and potentially
improved flexibility, together with the changes in taxation       expand the range of assets that can be held by the company.
of overseas dividends resulting in the majority of ITCs not       Prima facie, Condition A will give closed-ended investment
paying UK tax, will help to remove some of the barriers to        companies the opportunity to execute a wider range of
setting up ITCs in the UK. Historically, compliance with          investment remits without worrying about breaching
s1158 Corporation Tax Act (CTA) 2010 (and prior to that,          prescribed limits. Although the wording is not identical,
s842 ICTA 1988) harboured significant risk to ITCs as             the risk spreading concept is similar to that contained in
clearance was given retrospectively and annually and, due to      the definition of a closed – ended investment fund used
prescriptive tests, it suffered from a precipice problem. If a    in Chapter 15 of the Listing Rules. The listing condition
company failed a test, even by a very small margin, it would      (Condition B) now uses the EU definition of a regulated
be denied investment trust status and all gains that year         market, which is wider than the existing requirement for
would be taxable, with no opportunity for rectification.          shares to be admitted to the official UK list.
   The revised regime has three main features:                        Both conditions A and B are subject to further detailed
•	 a more principles based definition of ‘investment trust’ for   conditions which are set out in regulations.
   tax purposes
•	 the conditions in s1158 -1162 of CTA 2010 are
   substantially shortened, with revised criteria set out in
   regulations
•	 revised operational rules, covering application procedures
   and inadvertent breaches.

Definition of an investment trust – s1158 CTA 2010
Section 1158 CTA 2010 requires that an investment trust
must meet three conditions:
   Condition A – that the business of the company consists
of investing in shares, land or other assets with the aim
of spreading investment risk and giving members of the
Detailed conditions set out in regulations                         •	 include an undertaking to meet the conditions for
The requirements which must continue to be met by an                  subsequent periods
approved investment trust include the following:                   •	 include a copy of the company’s published
                                                                      investment policy
The close company test
                                                                   •	 contain evidence that ordinary shares are admitted to
The close company test will continue to operate in its                trading on a regulated market.
current form as set out in s439 CTA 2010. Contrary to
what was proposed in the original consultation, the quoted         Breaches
company exemption is to be maintained - an ITC would                  Once investment trust status is granted, it will continue
not be a close company if 35% of the voting shares are held        to apply subject to compliance with certain breaching
by the public and have been listed and dealt on a recognised       conditions. The regulations introduce the concept of minor
stock exchange.                                                    and serious breaches, in a similar way to the reporting fund
The 15% income retention test                                      regulations applying to offshore funds.
The original consultation had proposed to reduce the                  Minor inadvertent breaches for which there is a reasonable
maximum retention to 10%. In the final regulations, this           excuse and which are remedied as soon as reasonably
remains at 15%, but it is calculated as 15% of all income,         practicable will not cause a loss of investment trust status.
rather than on income from shares and securities. The              Serious breaches on the other hand cause loss of approval
amount of income permitted to be retained is however               and could arise for example where, in a ten year period, there
reduced if the company has reportable income from offshore         have been three minor breaches of the same condition, or
funds which has been accounted for as capital in accordance        four minor breaches of more than one condition. Failure to
with the SORP. From HMRC’s perspective this mechanism              comply with the close company test at any time, significant
ensures that reported income is distributed to investors,          over-retention of income (defined as over 5%) or failure to
and in practice it will be a key point to be alert to when         comply with eligibility conditions A to C in s1158 CTA 2010
determining the amount of any distribution.                        would also constitute serious breaches.
   The required distribution must be made before the filing           Particular care, as now, needs to be taken with the close
date of the company’s tax return – ie 12 months following the      company test, but also the published investment policy needs
end of the accounting period.                                      to be considered carefully to ensure that the ITC does not
   There is also a helpful development for investment trusts       risk breaching the eligibility conditions.
with low levels of income whereby the minimum level below
which a distribution is not required has been increased from       Distribution of capital profits and changes to
£10,000 to £30,000.                                                Companies Act 2006
                                                                   Historically, obtaining approval as an investment trust
Investment policy                                                  has required an ITC to have a clause in its memorandum
Any changes in the company’s published investment policy           or articles of association which prohibit the distribution
must be notified to HMRC.                                          as dividend of surpluses arising from the realisation of
                                                                   investments. This prohibition is removed in the
Breaches
                                                                   new regulations.
Any breaches of the regulations or the eligibility conditions
                                                                      In order to align company law with the tax regulations, a
must be notified to HMRC, along with details of any
                                                                   similar amendment is expected to be made to the investment
action taken.
                                                                   company rules in the Companies Act (CA)2006. At present
                                                                   a CA 2006 s833 investment company is prohibited from
All ITCs are required to make an up-front application
                                                                   distributing capital profits (other than by way of share
The existing system of retrospective confirmation of ITC
                                                                   buyback). This prohibition is also to be removed, although
status is replaced with a requirement to make an up-front
                                                                   the legislation to give effect to this will not be effective
application for approval. The deadline for this application is
                                                                   until April.
90 days after the end of the first applicable accounting period.
                                                                      This represents a significant potential change in the
HMRC will then respond or request further information
                                                                   investment trust legal framework. The ability to distribute
within 28 days before making a final decision. Boards will
                                                                   capital gains is not something which will necessarily appeal
need to review the Company’s proposed compliance with the
                                                                   to all companies but having the flexibility to re-evaluate
revised requirements and make appropriate arrangements for
                                                                   distribution policies is something which is likely to have a
transition to the new regime.
                                                                   significant impact in some cases.
   Applications for approval require to be made in writing
                                                                      The Companies Act is also to be amended to align the
and must:
                                                                   other conditions for investment companies with the revised
•	 specify the date from which approval is sought (this will
                                                                   tax regulations, in particular to reflect the removal of the 15%
   be the first day of an accounting period)
                                                                   holding condition and the revised listing condition.
•	 include a statement that the company meets (or will meet)
   the conditions
A ‘white list’ of financial transactions                                                                 Conclusion
In order to give greater certainty as to the types of                                                    The new regime has been generally welcomed as a positive
transactions which an ITC can enter into without running the                                             development for the UK investment trust industry. HMRC’s
risk that these will be deemed to be trading for tax purposes,                                           aim is to make the operation of the rules more practical and
a white list has been included in the revised tax regulations.                                           therefore give more certainty to those risking capital but,
This is aligned to the lists that apply for authorised funds and                                         given the current economic environment, without incurring
the Investment Manager Exemption.                                                                        any net cost to the Exchequer.
   The list includes various specified derivative contracts and                                             Although the rules are an apparent relaxation it is likely
currency transactions, which is welcome given the demand                                                 that HMRC will take a proportionate view when considering
for broader investment strategies in today’s markets. If a                                               applications – “does it look like and act like a listed closed
transaction which is not on the white list is entered into and                                           ended investment company” may be the overarching
subsequently deemed to be trading, this will be taxed as such                                            question as well as a consideration of each of the rules.
but will not taint any other transactions entered into by                                                However, interesting questions do present themselves for
the company.                                                                                             existing ITCs – for example does the new framework create
   This is all good news for the industry and should mean                                                the opportunity to restructure, or to add to holdings or to
that ITCs no longer have to set up subsidiary companies                                                  fine tune the investment strategy?
where they are concerned about the tax risk of trading, albeit                                              As we are already in the period where the new rules
this needs to be considered within the overall context of any                                            apply, consideration needs to be given in all cases to
trading activity being minor and ancilliary to the company’s                                             applying for investment trust status within the new regime.
main business consisting of investing in shares, land or                                                 HMRC guidance is expected very soon which will increase
other assets.                                                                                            understanding of how the new spread of risk test is expected
                                                                                                         to operate but, as there are no transition rules, companies
                                                                                                         would be advised to gain assurance of their status by
                                                                                                         considering their applications sooner rather than later.




Anne Stopford                                                         Dana Ward
T 020 7865 2285                                                       T 020 7728 3316
E anne.stopford@uk.gt.com                                             E dana.ward@uk.gt.com




© 2012 Grant Thornton UK LLP. All rights reserved. ‘Grant Thornton’ means Grant Thornton UK LLP, a limited liability partnership. Grant Thornton UK LLP is a member firm within Grant Thornton International
Ltd (‘Grant Thornton International’). Grant Thornton International and the member firms are not a worldwide partnership. Services are delivered by the member firms independently. This publication has been
prepared only as a guide. No responsibility can be accepted by us for loss occasioned to any person acting or refraining from acting as a result of any material in this publication.

www.grant-thornton.co.uk

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Grant Thornton UK - Investment company technical release 2012

  • 1. Investment company technical release March 2012 Revised tax regime for investment trust companies Introduction HMRC’s regulations on the modernisation of the tax rules company the benefit of the results of the management of for Investment Trust Companies (ITCs) were approved by its funds. Parliament in December 2011 and the new regime is effective Condition B – that the company’s ordinary shares must be for all accounting periods commencing on or after admitted to trading on a regulated market. 1 January 2012. Condition C – that the company is not a Venture Capital As an increasing number of investment companies have Trust or a UK Real Estate Investment Trust. chosen to establish themselves offshore in recent years, These new eligibility conditions largely do away with the HMRC hopes that a more principles based regime with 15% holdings test and the 70% income test and potentially improved flexibility, together with the changes in taxation expand the range of assets that can be held by the company. of overseas dividends resulting in the majority of ITCs not Prima facie, Condition A will give closed-ended investment paying UK tax, will help to remove some of the barriers to companies the opportunity to execute a wider range of setting up ITCs in the UK. Historically, compliance with investment remits without worrying about breaching s1158 Corporation Tax Act (CTA) 2010 (and prior to that, prescribed limits. Although the wording is not identical, s842 ICTA 1988) harboured significant risk to ITCs as the risk spreading concept is similar to that contained in clearance was given retrospectively and annually and, due to the definition of a closed – ended investment fund used prescriptive tests, it suffered from a precipice problem. If a in Chapter 15 of the Listing Rules. The listing condition company failed a test, even by a very small margin, it would (Condition B) now uses the EU definition of a regulated be denied investment trust status and all gains that year market, which is wider than the existing requirement for would be taxable, with no opportunity for rectification. shares to be admitted to the official UK list. The revised regime has three main features: Both conditions A and B are subject to further detailed • a more principles based definition of ‘investment trust’ for conditions which are set out in regulations. tax purposes • the conditions in s1158 -1162 of CTA 2010 are substantially shortened, with revised criteria set out in regulations • revised operational rules, covering application procedures and inadvertent breaches. Definition of an investment trust – s1158 CTA 2010 Section 1158 CTA 2010 requires that an investment trust must meet three conditions: Condition A – that the business of the company consists of investing in shares, land or other assets with the aim of spreading investment risk and giving members of the
  • 2. Detailed conditions set out in regulations • include an undertaking to meet the conditions for The requirements which must continue to be met by an subsequent periods approved investment trust include the following: • include a copy of the company’s published investment policy The close company test • contain evidence that ordinary shares are admitted to The close company test will continue to operate in its trading on a regulated market. current form as set out in s439 CTA 2010. Contrary to what was proposed in the original consultation, the quoted Breaches company exemption is to be maintained - an ITC would Once investment trust status is granted, it will continue not be a close company if 35% of the voting shares are held to apply subject to compliance with certain breaching by the public and have been listed and dealt on a recognised conditions. The regulations introduce the concept of minor stock exchange. and serious breaches, in a similar way to the reporting fund The 15% income retention test regulations applying to offshore funds. The original consultation had proposed to reduce the Minor inadvertent breaches for which there is a reasonable maximum retention to 10%. In the final regulations, this excuse and which are remedied as soon as reasonably remains at 15%, but it is calculated as 15% of all income, practicable will not cause a loss of investment trust status. rather than on income from shares and securities. The Serious breaches on the other hand cause loss of approval amount of income permitted to be retained is however and could arise for example where, in a ten year period, there reduced if the company has reportable income from offshore have been three minor breaches of the same condition, or funds which has been accounted for as capital in accordance four minor breaches of more than one condition. Failure to with the SORP. From HMRC’s perspective this mechanism comply with the close company test at any time, significant ensures that reported income is distributed to investors, over-retention of income (defined as over 5%) or failure to and in practice it will be a key point to be alert to when comply with eligibility conditions A to C in s1158 CTA 2010 determining the amount of any distribution. would also constitute serious breaches. The required distribution must be made before the filing Particular care, as now, needs to be taken with the close date of the company’s tax return – ie 12 months following the company test, but also the published investment policy needs end of the accounting period. to be considered carefully to ensure that the ITC does not There is also a helpful development for investment trusts risk breaching the eligibility conditions. with low levels of income whereby the minimum level below which a distribution is not required has been increased from Distribution of capital profits and changes to £10,000 to £30,000. Companies Act 2006 Historically, obtaining approval as an investment trust Investment policy has required an ITC to have a clause in its memorandum Any changes in the company’s published investment policy or articles of association which prohibit the distribution must be notified to HMRC. as dividend of surpluses arising from the realisation of investments. This prohibition is removed in the Breaches new regulations. Any breaches of the regulations or the eligibility conditions In order to align company law with the tax regulations, a must be notified to HMRC, along with details of any similar amendment is expected to be made to the investment action taken. company rules in the Companies Act (CA)2006. At present a CA 2006 s833 investment company is prohibited from All ITCs are required to make an up-front application distributing capital profits (other than by way of share The existing system of retrospective confirmation of ITC buyback). This prohibition is also to be removed, although status is replaced with a requirement to make an up-front the legislation to give effect to this will not be effective application for approval. The deadline for this application is until April. 90 days after the end of the first applicable accounting period. This represents a significant potential change in the HMRC will then respond or request further information investment trust legal framework. The ability to distribute within 28 days before making a final decision. Boards will capital gains is not something which will necessarily appeal need to review the Company’s proposed compliance with the to all companies but having the flexibility to re-evaluate revised requirements and make appropriate arrangements for distribution policies is something which is likely to have a transition to the new regime. significant impact in some cases. Applications for approval require to be made in writing The Companies Act is also to be amended to align the and must: other conditions for investment companies with the revised • specify the date from which approval is sought (this will tax regulations, in particular to reflect the removal of the 15% be the first day of an accounting period) holding condition and the revised listing condition. • include a statement that the company meets (or will meet) the conditions
  • 3. A ‘white list’ of financial transactions Conclusion In order to give greater certainty as to the types of The new regime has been generally welcomed as a positive transactions which an ITC can enter into without running the development for the UK investment trust industry. HMRC’s risk that these will be deemed to be trading for tax purposes, aim is to make the operation of the rules more practical and a white list has been included in the revised tax regulations. therefore give more certainty to those risking capital but, This is aligned to the lists that apply for authorised funds and given the current economic environment, without incurring the Investment Manager Exemption. any net cost to the Exchequer. The list includes various specified derivative contracts and Although the rules are an apparent relaxation it is likely currency transactions, which is welcome given the demand that HMRC will take a proportionate view when considering for broader investment strategies in today’s markets. If a applications – “does it look like and act like a listed closed transaction which is not on the white list is entered into and ended investment company” may be the overarching subsequently deemed to be trading, this will be taxed as such question as well as a consideration of each of the rules. but will not taint any other transactions entered into by However, interesting questions do present themselves for the company. existing ITCs – for example does the new framework create This is all good news for the industry and should mean the opportunity to restructure, or to add to holdings or to that ITCs no longer have to set up subsidiary companies fine tune the investment strategy? where they are concerned about the tax risk of trading, albeit As we are already in the period where the new rules this needs to be considered within the overall context of any apply, consideration needs to be given in all cases to trading activity being minor and ancilliary to the company’s applying for investment trust status within the new regime. main business consisting of investing in shares, land or HMRC guidance is expected very soon which will increase other assets. understanding of how the new spread of risk test is expected to operate but, as there are no transition rules, companies would be advised to gain assurance of their status by considering their applications sooner rather than later. Anne Stopford Dana Ward T 020 7865 2285 T 020 7728 3316 E anne.stopford@uk.gt.com E dana.ward@uk.gt.com © 2012 Grant Thornton UK LLP. All rights reserved. ‘Grant Thornton’ means Grant Thornton UK LLP, a limited liability partnership. Grant Thornton UK LLP is a member firm within Grant Thornton International Ltd (‘Grant Thornton International’). Grant Thornton International and the member firms are not a worldwide partnership. Services are delivered by the member firms independently. This publication has been prepared only as a guide. No responsibility can be accepted by us for loss occasioned to any person acting or refraining from acting as a result of any material in this publication. www.grant-thornton.co.uk V21465