UK: Financial Services And Markets Group Bulletin: A Review Of Financial Regulations And Tax Issues For FSA-Regulated Businesses - Autumn 2011


By Marco Bragazzi

The FSA recently published its further consultation paper on strengthening capital adequacy.

Capital Requirements Directive 3 (CRD 3) was the subject of consultation by the Commission during spring 2009 and was published in the Official Journal of the European Union on 14 December 2010. Under the original timetable of CRD 3 (and as reflected in CP 09/29) the relevant national laws, regulations and administrative provisions were to come into force by 1 January 2011. However, due to changes in the final wording, most of the CRD 3 amendments are now required to be implemented by 31 December 2011 at the latest.

Key changes

The CRD 3 changes highlighted in CP 11/9 include:

  • strengthening capital requirements in the trading book
  • higher capital requirements for re-securitisations
  • extending the prudent valuation framework
  • requiring enhanced public disclosures under pillar 3 of the capital framework
  • amending the FSA rules for various technical amendments to the CRD.

Impact on smaller firms

The good news is that the proposed changes in CRD 3 as detailed in the May consultation paper do not have an impact for smaller firms; they should only be relevant to banks and full scope firms that are carrying out principal broking. The changes, which are focused around market risk in the trading book, predominantly affect those firms with a value at risk model permission. However, as detailed in the consultation paper CP 09/29, for firms applying the standard method to equity risk, the CRD 3 amendments will require them to calculate specific risk on equity positions by applying an 8% cut to the sum of their net short and net long positions, with the reduced 4% previously applied being removed.

An important reminder

From January 2011, the new BIPRU 10 amendments came into force. The changes had a significant impact as they exempted limited license and limited activity firms from the scope of BIPRU 10. This meant that FSA 008 submissions were not required for these exempted firms.

However, full scope firms, irrespective of size, do have to apply BIPRU 10. One item to highlight as a reminder is that institutions are now no longer exempted from the large exposure rules. The relevant rule is found in BIPRU 10.6, where it states that firms can have exposures exceeding 25% of their capital resources "so long as the total amount of such exposures does not exceed €150m".

However, irrespective of whether the exposure exceeds €150m or not, the exposure cannot exceed 100% of the firm's capital resources. This is where a number of firms have been caught out as the FSA focuses on ensuring that concentration risk is managed, even where the exposure is with recognised established banks. It must be highlighted that BIPRU 10.6.33 allows the FSA to waive the 100% limit on a case-by-case basis in exceptional circumstances. We remind firms to look at their current banking exposures and apply for any waivers as early as possible where the limits prescribed in BIPRU 10.6 are exceeded.


By Tom Squire and Martin Connolly

Tom Squire and Martin Connolly discuss how new legislation is making the UK a more attractive domicile for UCITS funds.

HM Treasury has taken steps to further improve the attractiveness of the UK as a domicile for undertakings for collective investment in transferable securities (UCITS) funds. A consultation has been announced with a view to launching an authorised UK tax transparent fund (TTF) vehicle. Draft regulations for consultation are expected by late 2011 with secondary legislation implementing the regime expected by summer 2012.

The UK has typically not been the domicile of choice for UCITS funds, with the market standard being either Ireland or Luxembourg. The UK does have several attractive characteristics as a domicile for UCITS funds due to its robust regulatory process and extensive network of double tax treaties. However, these are often outweighed by factors such as the speed at which a fund can be launched and the perceived certainty and stability of the tax and regulatory environment offered by other jurisdictions.

The lack of a true TTF vehicle has also been one of the key areas where the UK has lagged behind. Competitor jurisdictions such as Ireland and Luxembourg have tax transparent vehicles such as the Common Contractual Fund and Communs de Placement respectively.

While the UK does offer a variety of legal structures for investment pooling, such as unit trusts, open-ended investment companies and investment trusts, it does not offer a true TTF vehicle to compete with Ireland and Luxembourg. Currently, only a number of pseudo-TTF vehicles, such as property authorised investment funds and tax elected funds, exist.

The lack of true tax transparency introduces an additional layer of taxation at the fund level, increasing the effective tax burden on investors due to withholding taxes being applied without regard to the underlying investor type or domicile, directly reducing fund performance and investor returns.

Non-TTFs are not tax neutral and introduce a cost to investing via a fund rather than investing directly. Fund managers often cite being able to achieve tax neutrality in the fund structure as a key consideration when selecting a fund domicile.

The implementation of UCITS IV into UK law from 1 July 2011, allowing for pan- European master-feeder UCITS structures, has provided the necessary spur for reform and the establishment of a truly tax transparent UK fund vehicle. A UK TTF would enable investors to pool their assets cross-border in a fund to obtain economies of scale without losing any withholding tax benefits associated with their country of domicile, i.e. achieve tax neutrality at fund level. This puts UK master funds on the same footing as those domiciled in offshore centres, which should attract the establishment of new master funds in the UK, particularly as fund managers seek to rationalise and restructure their fund ranges in response to the opportunities afforded under UCITS IV.

UCITS IV also introduces several other changes which should provide opportunities for the UK fund management industry, such as the European-wide passport for investment management companies which will allow UK management companies to manage non-UK domiciled UCITS funds. UCITS IV also facilitates the cross-border merger of UCITS funds from a regulatory perspective, although much remains to be done in other jurisdictions to make cross-border mergers viable from a tax perspective.

Investor demand for tax transparency also looks set to grow as the result of initiatives (such as the US Foreign Account Tax Compliance Act) which emphasise the transparency of holdings and the political pressure to move away from lightly regulated offshore centres driving the need for a UK TTF to maintain competitiveness.

Without the introduction of a TTF vehicle, the UK would risk losing funds under management and the associated jobs and economic contribution to other jurisdictions, a risk HM Treasury can ill afford in the current economic climate. A UK TTF would improve the UK's ability to compete as a fund domicile but there remains much more to be done in order to make the UK the domicile of choice for fund managers. For instance, while the Finance Act 2011 exempted investments made by funds in other funds from SDRT with effect from 20 July 2011 (subject to certain conditions), the failure to abolish SDRT Schedule 19 in its entirety has proved disappointing and continues to be an impediment to the competitiveness of the UK fund management industry.

Despite this, there remains an ongoing and constructive dialogue between the UK Government and industry figures to bring about the necessary changes to improve the UK fund management industry's competitiveness, attract new funds and eventually become the domicile of choice.


By Martin Sharratt

Martin Sharratt discusses the contentious situation relating to VAT exemption for pension funds and the latest test case being considered by the European Court.

The management of a pension fund is, in one sense, clearly a form of investment activity and from a layman's perspective it looks very much like something that ought to fall within the VAT exemption. However, as most of our clients will appreciate, VAT has its own logic and this is a subject which has confused experts and HMRC alike for decades.

Scope of exemption

The scope of the exemption is set by European legislation, which restricts the exemption for fund management services to "the management of special investment funds as defined by member states".

The European Court of Justice (ECJ) has ruled several times on the meaning of this phrase, first pondering at great length which services constituted "the management" and then (in 2007), in the JP Morgan Claverhouse case, ruling on how much discretion individual member states had in deciding which forms of investment fund should benefit from the exemption.

The ECJ held that the UK had applied the exemption too narrowly and that the management of an investment trust company should also be exempt. Following that decision, HMRC considered the implications for other investment vehicles and accepted that, to avoid distortion of competition, the exemption should be extended to several other forms of collective investment scheme – but not pension funds.

Test case

In the four years since the JP Morgan Claverhouse case there have been rumblings about a further test case which would challenge HMRC on this point and decide once and for all whether the management of a pension fund should, like the management of an investment trust, have been exempt all along. The name of the appellant, it was eventually revealed, was The Wheels Common Investment Fund Trustees Limited, joined by the National Association of Pension Funds.

The amounts of tax at stake are substantial and numerous backdated claims have been submitted, all of which have been 'stood over' and await the test case. The case has progressed slowly, however, and it was early in 2011 when it emerged that it had been heard by the Tax Tribunal, which had agreed that the matter should again be referred to the ECJ (or the Court of Justice of the European Union (CJEU) as it is now known). Again, there was a long wait while the parties deliberated on the wording of the questions, but the referral has now been made and the questions are in the public domain.

The appellants argue that, although not open to the public, occupational pension schemes do constitute a form of collective investment vehicle for the employers and employees, and as such fall within the meaning of "special investment funds".

The Wheels pension fund is a defined benefit scheme, however, and one of HMRC's strongest arguments is based on the "disconnect" (sic) between the amounts received as a pension by employees (fixed by reference to salary and length of service), and the amounts the employee pays into the pension fund and its investment return. It will be many months before we know how the CJEU approaches the issue or whether this distinction is relevant.

Legislative changes?

Meanwhile, the member states and the European Commission have been reviewing in depth how the VAT exemptions should work in the financial sector, with a view to updating the Directive and clarifying some of the contentious points. Many of these proposals have been fiercely resisted and will never see the light of day, but one, which has apparently survived multiple redrafts of the new Directive and seems to be accepted by all, would make the management of a pension fund exempt after all.

Pension fund managers, trustees and employers will need to keep an eye on these developments and should be thinking of lodging a protective claim for the VAT previously charged on the fund management services if they have not already done so. They should not, however, expect the final outcome any time soon.


By Adrian Walton

It is a common misconception that the tax advantages available for individuals investing under the Enterprise Investment Scheme (EIS) and for venture capital trusts (VCTs) do not apply to financial services businesses. This is primarily due to the 'other financial activities' exclusion in the relevant legislation. However, many types of businesses that operate in the financial services sector, including fund managers, corporate finance advisers, insurance brokers (but not underwriters) are likely to be 'qualifying companies' for EIS and VCT purposes, such that significant income and capital gains tax reliefs could be available for investors, potentially including management. In general, businesses will be carrying on qualifying activities for these purposes if they are trading companies (but not dealing in securities or financial instruments on their own account to a substantial extent) where any investments held are insignificant to the main trading activities.

It should be noted that EIS/VCT relief is not available for investments in limited liability partnerships carrying on qualifying activities. The investment must be into a limited company.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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