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Funds First Seminar September 2017 – highlights of some developments in funds


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Summary: This briefing sets out some of the highlights of the topics covered at our Funds First Seminar in September 2017, which we hope will also be of interest to those who could not attend the seminar itself. Please do get in touch if you want to discuss any of the issues raised in more detail.

At our recent Funds First seminar we examined some legal and market developments affecting investment managers. We considered how the Senior Managers and Certification Regime will apply to fund managers. We discussed key technical, market and practical points on ‘private REITs’ for real estate joint ventures and clubs. We also looked at three tax developments: corporate offences for failure to prevent the criminal facilitation of tax evasion, disguised remuneration and BEPS and interest deductibility.

Senior Managers Regime Extension

On 26 July 2017, the FCA launched a consultation paper regarding the extension of the Senior Managers and Certification Regime (SMCR) to all authorised financial services firms, replacing the Approved Persons Regime. A core set of requirements will apply to all FCA-regulated firms (except ‘limited scope’ firms). The FCA’s consultation closes on 3 November 2017 and final rules are expected to be published next summer. From our experience helping banks to prepare for the implementation of the original-scope SMCR, implementing these new requirements takes longer than you would think.  Our advice is to start as soon as you can.

We have set out some of the key changes below.

The Senior Managers Regime

  • The introduction of Senior Management Functions (SMFs), which the most senior people in firms (whether they are in the UK or overseas) must be pre-approved by the FCA to perform. Also all SMF holders must have Statements of Responsibilities setting out the areas for which they are personally accountable. 
  • The introduction of new ‘prescribed responsibilities’, each of which must be allocated to an SMF holder within the firm. Asset managers will be particularly interested in the FCA’s proposal to impose a personal regulatory duty for: “an Authorised Fund Manager’s value for money assessments, independent director representation and acting in investors’ best interests”.
  • SMFs will also be subject to a ‘duty of responsibility’, which means they are required to take the steps that it is reasonable for a person in that position to take, to prevent a regulatory breach from occurring in their area of responsibility.

The Certification Regime

  • The introduction of certification requirements that apply to all staff that are not SMF holders, but who pose a risk of significant harm to the firm or any of its customers.  Such individuals do not need to be pre-approved by the FCA,  but firms will be required to identify such staff and certify them as fit and proper to perform their roles, both upon recruitment and from then on at least annually.

Introduction of new Conduct Rules

  • This is a very significant change for the staff of authorised firms, who have never before been accountable directly to the regulators for their personal conduct (unless they have previously been Approved Persons). These new rules will apply to all employees (apart from certain administrative staff e.g. secretaries), which is perhaps the biggest change from the Approved Persons Regime.
  • There will be two tiers of Conduct Rules: the first tier will apply to all conduct rules staff; and second tier will apply only to SMF holders.  Firms will be required to provide training to ensure that staff subject to the Conduct Rules understand the applicable rules, and what these mean in practice for their particular roles.  
  • The FCA will be able to take enforcement action against employees if they breach the Conduct Rules.  In addition, firms must notify the FCA if formal disciplinary action is taken against an employee where the disciplinary action relates to any action, failure to act, or circumstance that amounts to a breach of any Conduct Rule.

Additional requirements for Enhanced firms

In addition to the core requirements, there will be more onerous rules applying to a small number of firms, whose size and complexity the FCA considers could pose a greater risk of harm to consumers or the market (so called ‘Enhanced firms’).  Firms with assets under management of £50 billion or more will qualify as enhanced firms. New requirements will apply, for instance ‘enhanced regime’ firms will need to produce a Management Responsibilities Map setting out management and governance arrangements.

‘Private REITS’ for joint ventures and clubs

A UK REIT is a UK tax resident closed-ended company that carries on a property rental business and satisfies certain conditions. In the seminar we selected a few key points of interest when looking at the company conditions for participating in the UK REIT regime:

  • Not a close company. However, this requirement has been relaxed and there are now certain exceptions.
  • Tax resident solely in the UK, although the company can be incorporated elsewhere (e.g. Jersey or Guernsey).
  • Admitted to trading on a recognised stock exchange - this includes overseas exchanges and TISE, The International Stock Exchange, appears to be the most common

The use of ‘private REITs’ is gaining in popularity, and this is a trend we expect to continue. This has been enabled by the overhaul of the REIT rules in 2012, in particular the relaxation of the close company rules, as a result of which a REIT will satisfy the close company requirement where at least 50% of the REIT is held by certain sovereign or institutional investors, including UK pension funds and other REITs.

We also shared our thoughts on three main commercial drivers of the use of private REITs:

  • Asset-specific: Acquisition of a UK company by a REIT can wash out a latent gain.
  • Investor specific: Certain investors can extract property rental business profits (which are exempt from tax in the REIT) tax free.
  • Onshoring: The REIT has increasing appeal against a backdrop of tax initiatives such as BEPS, as well as a general shift of certain investors towards tax-efficient onshore structures in certain circumstances.

Corporate offence of failure to prevent the criminal facilitation of tax evasion

The Criminal Finances Act 2017, coming into force on 30 September 2017, will bring in a new corporate criminal offence of failure to prevent the facilitation of tax evasion. In our seminar we highlighted three key points:

  • Where a corporate or partnership’s employees, agents or contractors facilitate the evasion of tax in the course of conducting business, the corporate or partnership itself can be criminally liable for their actions.  This is a strict liability offence and does not require senior management to have any knowledge of, or involvement in, the wrongdoing.
  • In order to develop reasonable procedures and to protect themselves from criminal liability, entities need to conduct risk assessments to identify the risks of facilitation in their business and then to develop policies which address the risks identified.  As the new offence applies to the evasion of UK tax and foreign tax, the assessment needs to include the entity’s business undertaken outside the UK as well as in the UK. 
  • In the event that an entity was found criminally liable under the offence, it would be subject to a potentially unlimited fine.  The  consequences of a criminal conviction are also likely to be very damaging both commercially and from a reputational perspective. Firms involved in public procurement work may also be debarred from the public procurement tender process.

The new offence also raises issues from an FCA perspective. FCA-authorised firms are required to take reasonable care to establish and maintain effective systems and controls to prevent the risk that they might be used to further financial crime (SYSC 3.2.6R and SYSC 6.1.1R).  We can therefore expect the FCA to make enquiries of firms as part of their financial crime reviews to assess what systems and controls are in place to address the new offence.  In addition, under the SMCR, the senior manager responsible for financial crime should have oversight of the systems and controls (in respect of business undertaken outside the UK as well as within) necessary to address the new criminal offence. 

Although HMRC recognises that it will take time to implement all prevention procedures, it will be important to have assessed risks and developed an implementation plan for appropriate prevention procedures by 30 September 2017.  Entities will also need to demonstrate senior management commitment to preventing tax fraud.

We are currently assisting a range of clients to prepare for the introduction of the new offences and to conduct their risk assessments, and have developed a set of template questionnaires for different sectors, which can be used to identify the risks of facilitation. For further information, please get in touch.  

Disguised Remuneration

The last few years have seen significant changes to the tax treatment of sums received by executives in connection with the performance of investment management services; the key points of which we have set out below. Needless to say this collection of rules means planning is complex and attention to detail is vital to avoid any unwanted surprises.

  • Disguised Investment Management Fee Rules (DIMF Rules), which subject ‘management fees’ to self-employed income tax and National Insurance Contributions (NICs), unless the ‘management fee’ falls within specific carve-outs for return of investment; ‘carried interest’; or co-investment return.  Generally, genuine arm’s length carry and co-invest arrangements where there are no guaranteed returns, should fall outside the scope of the DIMF charges BUT, the criteria for each carve-out are closely defined.
  • Special capital gains tax computational provisions for carried interest, which operate alongside ordinary computational provisions for fund returns, to subject executives’ profit-linked returns to a minimum tax rate of 28% on their actual economic return, displacing the so-called ‘base cost shift’.
  • Income-based carried interest rules, which are designed to ensure that a fund manager’s profit-linked returns will only be subject to CGT treatment where the underlying fund returns are investment in nature. This is achieved by subjecting a proportion (up to 100%) of the fund manager’s profit-linked return to self-employed income tax and NICs where the weighted average holding period of the funds’ investments is less than 40 months. 

The recent extension of the Disguised Remuneration Rules in Part 7A ITEPA to the self-employed is a further hurdle to watch out for in planning complex executive remuneration arrangements.

Executives should note, that it is no longer possible to shelter ‘carried interest’ or ‘management fees’ by transferring them to connected entities, persons or trusts as the carry or fee will nevertheless be treated as arising to the individual executive, although there are provisions to prevent double tax.

The tax treatment of UK resident/non-domiciled individuals has also been subject to significant recent changes.  In the seminar we highlighted some of the matters for UK resident/non-domiciled executives to look out for:

  • Changes to the UK tax treatment of offshore trusts means it may be prudent to review existing structures that house ‘carry’ to make sure their tax treatment under the new rules going forward is understood. 
  • The remittance basis for management fees and ‘carry’ under the new rules is significantly restricted, as carry/fees will broadly only be treated as foreign situs/source where the investment management services are performed outside the UK with limited scope for apportionment, particularly where an income tax charge is in point under the DIMF rules.
  • For long term UK resident/non-domiciled executives who are treated as deemed domiciled for all UK tax purposes, there is a reasonably generous re-basing relief for directly held foreign assets including offshore reporting and non-reporting funds, subject to satisfying certain conditions.  The rules do not however operate to re-base ‘carried interest’.
  • Transitional ‘mixed fund’ cleansing rules for long term UK resident/non-domiciled individuals may be worth consideration in relation to recent fund realisations for example, as it may be possible to carve out a pot of ‘clean capital’ that could be remitted to the UK for spending without further tax.


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