On 11 November 2011 HM Revenue & Customs ("HMRC") published the "final" draft Investment Trust (Approved Company) (Tax) Regulations 2011. The regulations supplement the new legislation on investment trusts included in Finance Act 2011 and set out the detailed rules for investment trusts under the new regime. The regulations update the draft regulations published in May 2011, further information on which may be found by clicking here.
The regulations will come into force on 1 January 2012 and cover the application process for becoming an investment trust, the conditions to be met and the consequences of breaching those conditions. The regulations also provide a "white list" of transactions which will not be treated as trading.
The changes from the draft regulations include provisions for investment trusts investing in non-reporting offshore funds and some further minor amendments.
Investing in Non-Reporting Offshore Funds
Where an investment trust holds an interest in a non-reporting offshore fund, any gain realised by the investment trust on disposal of that interest would normally be treated as an offshore income gain and taxed as income instead of capital. The regulations provide for two situations where a gain realised on the disposal of an interest in a non-reporting offshore fund will be treated as capital.
Treatment as a Reporting Fund
The first situation is where:
- the investment trust has access to the accounts of the non-reporting offshore fund, including sufficient information to allow it to calculate the reportable income of that fund, and
- the investment trust itself calculates the reportable income and includes the excess of that amount over the amount actually distributed by the fund in the investment trust's income available for distribution for that period.
Where these conditions are met, the investment trust may treat its interest in the non-reporting offshore fund as if it were a reporting fund.
Index Tracking Funds
The second situation is where the investment trust has an investment policy which aims to replicate an index based on shares or securities listed on a recognised stock exchange and it acquires its interest in the non-reporting offshore fund in order to reflect the composition of that index.
The application process allows an investment trust whose shares are not yet listed to apply up to 60 days in advance of the listing on condition that it provides HMRC with confirmation of that listing within 60 days. Further, an investment trust may apply before the start of the first accounting period for which it is seeking approval on condition that it informs HMRC of the start of the accounting period.
The regulations have introduced a provision stating that, where the information set out in the conditions above is not provided, the investment trust will be treated as if it had never applied for approval. This contrasts with the first draft regulations, which allowed the approval to continue subject to a subsequent breach of the conditions.
Where an investment trust is being wound up, it will continue to be treated as approved until the end of the winding-up process provided it was approved in the accounting period immediately prior to the winding-up.
This is a welcome improvement on the draft regulations, which only allowed the approval to continue for a maximum of 12 months.
The rules on breaches of the conditions have been widened. Under the draft regulations, breaches of only certain conditions would be taken into account as breaches which would result in an investment trust's approved status being revoked. Under the revised regulations, a breach of any of the conditions set out in the regulations will now be taken into account. In addition, the breach provisions have been extended to cover breaches of the conditions set out in Finance Act 2011.
Amendments to Tax Returns
The regulations provide that, where an investment trust has amended its corporation tax return (either voluntarily or following an enquiry), it must make a further distribution within 180 days of the amendment if such a distribution is required to meet the 15% retention test.
Certain gaps in the draft legislation remain. No guidance has been included on the spread of risk test while the promised anti-avoidance legislation in relation to the close company rules is still awaited. However, the explanatory note to the regulations confirms that HMRC is preparing guidance (albeit that the scope of the guidance is not confirmed) which should be published before the regulations come into effect.
Perhaps most notably, the regulations do not contain any detailed commencement provisions and with less than 2 months until the implementation date it is still not known when existing investment trusts will be required to apply to enter the new regime.
The new rules relating to investments in non-reporting offshore funds will be welcomed as these should help investment trusts avoid tax charges on normal investment activity and, in relation to index tracking funds, bring them into line with offshore funds and authorised investment funds. The extension of the approval period to cover the whole of the winding-up of an investment trust is also helpful.
The extension of the breach rules is less positive and will require investment trusts to monitor their position carefully to ensure no breaches occur. However, it is worth noting that most breaches (other than serious breaches) will not count if they are promptly notified to HMRC and remedied.
Given the short time period until the regulations come into force it is disappointing that we still await guidance on the spread of risk test and the timing of the transition to the new regime.
For further information, please contact:
Head of Tax
0141 271 5778
020 7002 8538
Director, Financial Services
020 7002 8540
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This briefing is written as a general guide only. It is not intended to contain definitive legal advice which should be sought as appropriate in relation to any particular matter.