For years, retail investment funds have been subject to corporation tax at a special rate of 20% - special, because for a long time, the main corporate rate was 30% or more. But recently, corporate rates have been gradually coming down, till at last, this summer we are told that the main rate will eventually go down to 18% by 2020.
But what about authorised investment funds? Are they to be included in the new bonanza for corporates? Or will they continue to be taxed at the same 20% rate?
This isn't just an esoteric point for experts who specialise in investment funds. A lot of people invest in these funds either through a pension scheme or an ISA.
But pensions don't pay tax do they? No they don't, but the companies making up the investment portfolio do. And this includes the unit trusts and OEICs that are listed in the brochure when people are first introduced to their workplace pension, funds like Blue Sky Growth Fund, Cautious Balanced Accelerator Fund and the like (you do remember ticking the box don't you?)
In the following article we shall use the term "unit trust" to cover both unit trusts and OEICs, unless the context requires otherwise. Furthermore, we shall be talking about authorised unit trusts, not the unauthorised version which is taxed differently.
There are two other types of authorised fund, being the authorised contractual schemes, which were introduced last year. However, we don't need to worry about them - they are "look-through" vehicles with no tax being paid at the fund level.
Both unit trusts and OEICs are fund vehicles designed to pool investors' money together, which is then used to invest in various types of asset, the most common of which are equities.
A unit trust is, as the name implies, a trust. It has a set of trustees who hold the trust assets on behalf of the investors who are its beneficiaries. A Manager is appointed to actually make the investment decisions of buying, holding or selling the underlying investments.
An OEIC - short for open ended investment company - can be regarded as the corporate equivalent of the unit trust. The assets are held by the OEIC, which has its own legal personality, with the Depositary taking over equivalent functions of the Trustees, and an "Authorised Corporate Director" that is the equivalent of the unit trust Manager.
Both vehicles are similar in that they have variable "share capital". Investors buy or sell units or shares from the fund itself. Unlike the case of buying or selling shares on the stock exchange, there is no need to find a counterparty to the transaction - either a seller or a buyer, as the case may be. The fund itself creates or redeems the required number of units or shares to satisfy investor demand (see the diagram below).
For tax purposes, (authorised) unit trusts are treated as companies, with the unitholders being treated as shareholders1. OEICs are of course, companies in their own right, so they are automatically subject to corporation tax and their shareholders are treated like shareholders - because that's what they are.
However, because they are both fund vehicles, they enjoy particular tax benefits:
Before we look at how the legislative provisions govern the special tax rate, it is worth pointing out that unit trusts aren't likely to pay as much tax as a standard company:
So even if it turns out that the tax rate for unit trusts is to remain at 20%, it is only a relatively small proportion of the profits that will come within the charge.
Although the rate has always been 20%, this has never been explicit in terms of the legislation. Unit trusts are treated as companies and are subject to corporation tax - however, a special rate has always applied:
One important point to note - although the rate is set by reference to income tax rates, it is corporation tax that unit trusts pay on their taxable profits.
|Until 2006/07||2007/08||From 2008/09|
|Unit trusts/OEICs subject to corporation tax||ICTA 1988 s 468(1A).||ICTA 1988 s 468(1A).||ICTA 1988 s 468(1A) and CTA 210 s 614.|
|Which income tax rate?||Lower rate.||Savings rate.||Basic rate.|
|Where to find it?||ICTA 1988 s 1A(1B).||ITA 2007 s 7.||FA() s 1(2)(a) for each year except FA 2012 s 1(1)(a), 1(2)(a)|
We need to look at what the Finance Bill 2015-16 says. We are told that12:
On its own this clause should also cover unit trusts. Except for the fact that we have that special provision in the tax legislation at CTA 2010 s 614 that sets the rate at the basic rate of income tax.
Accordingly, this latter provision needs to be amended if unit trusts are to be taxed at the same rate as other companies. The simplest solution would be a straightforward repeal. But there is no amending provision in the Finance Bill which achieves the required result. Nothing at all.
So is this going to be the state of affairs? Funds to be taxed at 20% while the companies they invest in enjoy the lower 18% rate?
I have written a letter to HMRC!
Well it's so easy these days to send an email. Whether I will get a response or not is another matter!
Date: 31 July 2015
Subject: Corporation Tax Main Rate and Authorised Investment Funds
Dear Miss Milner
I have a query about the forthcoming changes to the corporation tax main rate, which is intended to come down to 18% by 2020.
For many years, authorised unit trusts and OEICs have been subject to corporation tax at a special rate of 20% - this was at a time when the main corporation tax rate was higher at 30-33%. Technically they are taxed at the basic rate of income tax currently in force - which happens to be 20% (ICTA 1988 s 468(1A), followed by CTA 2010 s 614).
What is going to happen to authorised funds when the main corporate tax rate starts decreasing?
The Finance Bill as it currently stands sets out the future rates in Clause 7. However, these changes wouldn't apply to authorised funds as they would still be subject to CTA 2010 s 614. I can't find anything in the Bill that repeals the latter provision.
Is this intentional? Or is it intended that authorised funds will also be subject to the same 18% corporate rate in due course?
Thanking you in advance.
I shall keep you all updated if I get a response.
Update 5 August 2015 at 18:15
I have just received the following response:
Dear Mr Chanda
Thank you for your email. As you note, and as set out in CTA 2010 s 614, the rate of corporation tax in relation to an open-ended investment company is related to the basic rate of income tax, not the rate of corporation tax. The government has no plans to change this link.
Of course this doesn't answer the question directly. The funds rate will remain linked to the basic rate of income tax – whether this rate will also come down to 18% is another matter. It is unlikely that such a rate change will be made just to satisfy the requirements of retail investment funds.
However, as mentioned earlier in this article, these funds don't pay much tax anyway, given the way that they are structured. Accordingly, the anomaly between the funds rate and the main corporate rate is unlikely to have an adverse impact.
(This article can be downloaded in PDF format at Academia.edu)
The information provided in this article is for general information purposes only. The information is not intended to be comprehensive or to include advice on which you may rely. You should always consult a suitably qualified professional on any specific matter.
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