UK Hedge Funds Electrnic Newsletter

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Investment Management & Real Estate

Rain or shine?*Alternatives Investment Funds Electronic Newsletter

November 2007 Nex

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Click on the links below to navigate directly to each article

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Alternatives Investment Funds Electronic Newsletter // November 2007

ContentsClick on the links below to navigate through the document

Flat rate for capital gains tax – Pre-Budget Report 2007

Implementation of the CRD and ICAAP

Dutch tax regime adapted for alternatives

Securitisation in the UK

Commodities trading and VAT

Consultation paper on offshore funds

Working late?

Taxation of non-domiciled partners – Pre-Budget Report 2007

Income tax shelters – has anti-avoidance effectively closed the market?

Proposed changes to the investment manager exemption

Changes to rules for claiming non UK tax residence

‘PricewaterhouseCoopers’ refers to the network of member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity.

By: Richard Hutchinson +44 (0)20 7212 8403 and Mark Waddilove +44 (0)20 7213 5786

Click on each PricewaterhouseCoopers author’s name to contact them directly via email Nex

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Flat rate for capitalgains tax

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By: Richard Hutchinson +44 (0)20 7212 8403 and Mark Waddilove +44 (0)20 7213 5786

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Flat rate for capitalgains tax

The UK government has announced in its Pre-Budget Reportthat it will replace the three current capital gains tax rates(10%, 20%, and 40%) with a single rate of 18%, effective6 April 2008. This change only applies to individualsand trustees.

The rate change will be accompanied by the abolition of bothbusiness asset taper relief and taper relief for non-businessassets and the removal of the indexation allowance for assetsowned since before 1998.

The loss of business asset taper relief will increase theeffective rate of capital gains tax payable by individuals whosell shares after 6 April 2008, including those who acquiredshares in the expectation that business asset taper reliefwould be available in the next two years.

As the changes are to have effect from 6 April 2008, theremay be some opportunity to restructure the terms of currentand past transactions to mitigate additional tax cost, but theremay be commercial constraints on what can be achieved.

The proposed changes in the legislation are not published yetand it is therefore uncertain whether anti-avoidance legislationwill be introduced. However, individuals must start to considerwhether it is better to crystallise the tax charge at a rate of10% now (assuming that full business asset taper relief hasbeen obtained) or defer it but suffer tax at a rate of 18% or ahigher rate for assets owned since before 1998 because ofthe removal of the indexation allowance.

Click on each PricewaterhouseCoopers author’s name to contact them directly via email

mailto:[email protected]?subject=Link%20from%20UKHF%20ENews





By: Jonathan Howland +44 (0)20 7212 5811


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Implementation of theCRD & ICAAPTime is running out for the implementation byhedge fund managers of their ICAAP, the InternalCapital Adequacy Assessment Process.

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By: Jonathan Howland +44 (0)20 7212 5811

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Implementation of theCRD & ICAAPTime is running out for the implementation byhedge fund managers of their ICAAP, the InternalCapital Adequacy Assessment Process.

From 1 January 2007, the rules governing regulatory capitalchanged as a result of the implementation of the CapitalRequirements Directive (‘CRD’). The CRD itself wasimplementing across the EU the measures of the revisedBasel framework (‘Basel II’). The new rules are mandatoryfrom 1 January 2008.

Under Pillar 2 of the CRD, all investment firms caught withinthe scope of the CRD must have an ICAAP. It is intended toensure that investment firms hold internal capital that isconsistent with their risk profile and strategy. The processobliges investment firms to:

• Carry out regular assessments of the financial resourcesthat it considers adequate to cover the nature and level ofrisks to which it is or might be exposed;

• Identify the major sources of risk to its ability to meet itsliabilities as they fall due;

• Conduct stress and scenario tests;

• Ensure that its processes, strategies and systems requiredby the overall Pillar 2 rule and used in its ICAAP are bothcomprehensive and proportionate to the nature, scale andcomplexity of the firm’s activities; and

• Document its ICAAP.

The size and complexity of firms will alter their ICAAPrequirements but it does not necessarily require additionalcapital. Many firms have found their capital resourcesunder Pillar 1 (‘Capital Resources Requirement’ or ‘CRR’)adequately meet any risks identified in their ICAAP, but thiscannot be assumed. The FSA expects senior managementto be involved in the ICAAP process, devoting sufficient timeand resources to its production. It has already providedfeedback on many firms’ submissions and not all have metits expectations.



By: Sander Eijkenduijn +44 (0)20 7804 5969 and Clark Noordhuis +31 20 568 6717


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Dutch tax regime adaptedfor alternativesAn improved tax regime has made theNetherlands more tax efficient both for hedge fundmanagement activities and fund vehicles.

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By: Sander Eijkenduijn +44 (0)20 7804 5969 and Clark Noordhuis +31 20 568 6717

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Dutch tax regime adaptedfor alternativesAn improved tax regime has made theNetherlands more tax efficient both for hedge fundmanagement activities and fund vehicles.

With the alternative investment industry growing fast, theDutch tax authorities are competing to create an efficientenvironment. Recent changes in both tax practice andregulation have been designed for just this purpose.There is now a beneficial fiscal environment both foralternatives investment firms and the funds they manage.

In particular, the Netherlands has become one of the fewplaces in Europe to offer certainty regarding the tax treatmentof offshore funds advised by investment managers basedwithin the country. Although the Netherlands does not havea formal tax exemption embedded in law, the local taxauthorities do give favourable rulings. In several cases,they have confirmed that funds will not be treated asbeing onshore.

For alternatives managers that wish to market alternativeinvestments onshore within Europe, there is a new more,modern fund, vehicle called the ‘Vrijgestelde

beleggingsinstelling’ (VBI). This is fully exempt from Dutchcorporate income tax and withholding tax. It can be used fora broad range of alternative investment styles, such asfund-of-funds, feeder funds, infrastructure funds, real estatefunds, money market instruments, swaps, commodity indexfunds and carbon emission rights, etc.

Finally, the Netherlands are increasingly popular with hedgefunds as a jurisdiction for locating their investment platformsfor worldwide investments. The extensive tax treaty network,the participation exemption for equity investments, theabsence of capital tax and cooperative tax authorities, are keyadvantages for offshore funds selecting the Netherlands.




By: Robert Mellor +44 (0)20 7804 1385 and Lachlan Roos + 1 646 471 0025


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Securitisation in the UKThe new permanent tax regime

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Securitisation in the UKThe new permanent tax regime

Securitisation began in the UK in the 1980s and hassince been mostly used by banks as part of managingrisk in their balance sheets and to help meet regulatorycapital requirements.

However, in recent times it has become a key structuring toolfor many within the alternatives market, particularly within thehedge fund space. The process enables funds to securitiseor package debts of differing credit ratings, and to tailor theend risk/reward product to different clients.

The EU introduction of the requirement for listed companiesto use International Accounting Standards (IAS) createda difference of treatment between IAS and UK GAAP, resultingin difficult tax positions for UK securitisation vehicles.Representations were made by the industry and it wasannounced by the UK Government that a permanent taxregime for securitisation companies would be created.

In the UK, for periods beginning on or after 1 January 2007,where an entity meets the definition of a ‘securitisationcompany’ it will be taxed under the new regime, whereby onlyretained profit, which can be nil if so decided by the directorsof the entity, is taxed. There are various conditions to be metfor the regime to apply. Also where certain of these arebreached the favourable tax treatment will be lost and cannotbe reinstated.

The favourable regime has taken a global approach andcovers not only UK-resident entities but also non-residententities with a UK permanent establishment. The regime alsoincludes extended definitions to incorporate Sharia-compliantbonds (otherwise referred to as ‘sukuk’-issuing companies)into the securitisation regulations, such that they may alsoobtain any favourable tax treatment.





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The favourable regime has taken a globalapproach and covers not only UK-residententities but also non-resident entities with a UKpermanent establishment.

The UK securitisation regime is a rapidly changing sector,and the tax rules are new and may face further legislativechange as we move forward. However, the UK now hasa model to compete with the securitisation platforms foundin continental Europe.




By: Andrew Millin + 44 (0)20 7212 7995 and Shima Heydari +44 (0)20 7213 3631


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Commodities trading and VATThe VAT rules applicable to trading in energyand other commodities are complex and differ inmany aspects to the general VAT rules applicableto the financial services sector.

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By: Andrew Millin + 44 (0)20 7212 7995 and Shima Heydari +44 (0)20 7213 3631

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Commodities trading and VATThe VAT rules applicable to trading in energyand other commodities are complex and differ inmany aspects to the general VAT rules applicableto the financial services sector.

Given the volume and amounts involved there are potentiallysignificant risks both in terms of VAT liability and VATcompliance. Hedge funds need to ensure that their systemsare updated to comply with these complex rules and that allVAT opportunities are recognised.

Many of the contracts traded in the energy market appear tobe, on the face of them, ‘financial’. However, in many cases,the contract reference point will be an underlying deliverablecommodity with differing VAT treatment. The VAT liabilitiesdepend on a number of factors, including the type of energy,the type of contract and where the supply is treated as takingplace, and it is vital, therefore, that businesses apply thecorrect VAT treatment.

Clients should take advantage of the Energy Networkestablished by PricewaterhouseCoopers which ensurescross-border knowledge of VAT liabilities and requirementswhen trading in physicals and derivatives in otherMember States.





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Proposed changes in UK tax rulescreate opportunities for offshore hedge fundsand fund of funds to distribute to UK investors

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By: Martin Smith +44 (0)20 7212 5524, Robert Mellor +44 (0)20 7804 1358 and Elizabeth Stone + 44 (0)20 7804 9678




By: Martin Smith +44 (0)20 7212 5524, Robert Mellor +44 (0)20 7804 1358 and Elizabeth Stone + 44 (0)20 7804 9678

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Proposed changes in UK tax rulescreate opportunities for offshore hedge fundsand fund of funds to distribute to UK investors

The Chancellor’s Pre-Budget Report announced the launch ofa consultative document outlining a framework for theoverhaul of the current UK ‘offshore funds regime’.Whether a UK investor is taxed on income or capital inrelation to any gains made on disposal of a holding in anoffshore fund vehicle is determined by whether the vehiclecan meet certain conditions imposed under the offshore fundsregime or not. Given the tax differential between income,which will continue to be taxed at 40%, and capital goingforward the application of the offshore funds rules will be ofmuch greater significance.

The current offshore funds regime focuses on the need for thefund to physically distribute its income returns for any givenperiod in the form of cash. The new regime focuses on taxreporting, and contains no requirement to distribute cash.For alternative funds this means that the fund may retain andreinvest its assets, while also looking to attain capital treatment

on disposal gains for its UK investors, ultimately saving themup to 22% in tax compared to the current tax regime.

Under the current proposals, analysis will be required on acase-by-case basis, to determine what proportion of returns,during the life of any holding by a UK investor, can bedeemed to be capital. The remaining returns would be subjectto tax as income in the hands of the UK investor on an annualbasis. As recent and continuing developments regarding thetreatment of derivatives and shorting techniques suggest thatcertain hedge fund returns could properly be regarded ascapital and not income, hedge funds should now actively beassessing whether they could obtain ‘reporting fund status’under the proposed new regime.

Consultation on the new reporting fund regime is dueto close in early January 2008, after which draft regulationswill be published.





By: Paul Hardy +44 (0)20 7212 4908, Jonathan Williams +44 (0)20 7804 8294 and Joanna Klaentschi +44 (0)20 7804 3869


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Working late?HMRC has always considered that travelling betweena permanent workplace and home is an ordinarycommuting journey and therefore a private journeyfor tax and NIC purposes.

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By: Paul Hardy +44 (0)20 7212 4908, Jonathan Williams +44 (0)20 7804 8294 and Joanna Klaentschi +44 (0)20 7804 3869

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Working late?HMRC has always considered that travelling betweena permanent workplace and home is an ordinarycommuting journey and therefore a private journeyfor tax and NIC purposes.

So what happens if an employer bears the cost of this travel?Strictly the cost is a benefit in kind and tax and NI will be due.However, historically HMRC has exempted the cost of travelhome borne by an employer, where an employee has workedlate at night from a tax and NIC charge.

But HMRC is in the process of reviewing this treatment oflate-night travel by taxi and its revised guidance in this areahas been distributed for consultation. As part of this processHMRC is considering how to resolve outstanding caseswhere it contends the exemption does not apply and tax andNIC are due. Meetings have been held between HMRCofficials, PricewaterhouseCoopers and other advisory firmsand representative bodies in connection with this.

In summary, HMRC acknowledged it has much work to do inorder to be able to settle open cases for earlier years and toreach agreement with employers on the basis for interpretingthe legislation for the future.

So, if you meet the costs of late`-night taxis for employees,we recommend you review your policy and internal controls toensure the conditions for exemption, as they stand, are met.We would be pleased to assist you to consider how best toproceed in this area.





By: Mark Waddilove +44 (0)20 7213 5786


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Taxation of non-domiciled partnersPre-Budget Report 2007

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Taxation of non-domiciled partnersPre-Budget Report 2007

The Government announced proposals to introduce legislationin the 2008 Finance Bill that will include a new tax charge forthose who wish to continue to use the remittance basis oftaxation. From 6 April 2008, a non-UK-domiciled individualwho has been resident in the UK for seven out of the past 10years will only be able to use the remittance basis of taxationif they pay an additional tax charge of £30,000 per annum.This charge will be in addition to any tax payable on theincome or gains remitted to the UK.

In addition to this new charge, those non-UK-domiciledindividuals who have unremitted foreign income of more than£1,000 will not be able to claim certain allowances, includingthe personal allowance currently set at £5,225.

Those who do not wish to pay the additional £30,000 annualcharge, must report and pay tax on their worldwide incomeand gains. This will bring them in line with UK-domiciledindividuals. The Government also announced that the annual

charge may be higher for those who have beenresident in the UK for longer than 10 years, but this isstill under consultation.

Finally, and potentially most significantly, the Government willintroduce legislation to deal with what the Chancellor referredto as ‘anomalies in the detailed remittance rules’. Thesechanges will affect a number of planning techniques that arecommonplace with non-UK-domiciled individuals – the HMRCpress release1 refers specifically to ‘ceased source’ planning,offshore trusts and company structures and extending themeaning of the term ‘remittance’.


1 HMRC media release – 09.10.07


By: Lynne Rowland +44 (0)20 7213 5632


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By: Lynne Rowland +44 (0)20 7213 5632

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For the last decade we have seen billions of pounds ofinvestment into film partnerships, with the result that theHMRC-accepted sale and leaseback structure is in itsdeath throes as new legislation restricts tax relief to thosecompanies which are actively involved in the film business.Too much cash was flowing out of the Treasury in the form oftax refunds and increasingly sophisticated schemes sought toprovide investors with tax mitigation rather than tax deferral.Needless to say, the demand for film structures continues inthe form of sole trader investments that seek to circumventthe partnership restrictions on loss relief and use GAAP togenerate losses rather than film relief. The schemes availablewere initially on a bespoke basis with high entry levels torestrict the numbers, but we are increasingly seeing entrylevels falling to encourage investment. This is a double-edgedsword, as HMRC may argue that individuals investing atmodest levels are not taking the same risks as someoneinvesting, say, several million pounds, and consequently mayrefuse loss relief.

Another popular area is ideas that provide tax breaks and aregood for the environment. Unfortunately the early carboncredit schemes did not provide the tax breaks anticipated,and there are no specific tax breaks for investmentsinto wind farms. Product providers are still trying to structurebio-fuel plants, but the lead time from commencementof construction through to the first commercial use canbe as long as five years, which plays havoc with cashflowprojections – no tax relief can be enjoyed until the plant is incommercial use.

The other much-loved investment is property. Investors arecomforted by investing into something tangible that theyunderstand, and some of the ideas that were being promotedearlier this year were proving so popular that HMRCintroduced anti-avoidance before the deals had financiallyclosed. There were a lot of angry investors and disappointeddevelopers at the time, but the Treasury was anticipating ahuge level of refunds being requested and had to dosomething drastic, if unpopular.



By: Lynne Rowland +44 (0)20 7213 5632

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HMRC treats a lot of retail ideas with a healthyscepticism and it is par for the course for taxrefunds to be withheld until HMRC iscomfortable, or has run out of reasons tocontinue to withhold.

There will probably be a small amount of enterprise zonecapacity available this year, and also structures offeringsyndicated buy-to-let portfolios. The big question is whetherclients will continue to plough money into property when thesigns are that the market is heading for saturation, but again,the comfort blanket of a bricks and mortar investment willprobably prevail.

The introduction of the tax avoidance disclosure regime hasplayed a big part in offering HMRC advance warning of newtax strategies. We are seeing more and more ideas beingbrought to market before the final thinking has been doneto avoid disclosure for as long as possible. This makes itextremely difficult for ideas to be shared and publicised andfor a detailed analysis of the structure to be provided at anearly stage.

The message is that there are ideas around, but they arenot as easy to access as they were perhaps five years ago.HMRC treats a lot of retail ideas with a healthy scepticismand it is par for the course for tax refunds to be withhelduntil HMRC is comfortable, or has run out of reasonsto continue to withhold. This does mean that investorshave to understand that the outcome can be uncertain, andnot easy to predict from a cashflow perspective, but evenwith a negotiated settlement, it can still be worth entering intothe planning.



By: Robert Mellor +44 (0)20 7804 1385, Debbie Payne + 44 (0)20 7213 5443 and Lachlan Roos + 1 646 471 0025


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Proposed changes to theinvestment manager exemptionOn 9 October the Chancellor published his Pre-Budget Report (PBR)which included proposed changes to the legislationgoverning the investment manager exemption (IME).

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Proposed changes to theinvestment manager exemptionOn 9 October the Chancellor published his Pre-Budget Report (PBR)which included proposed changes to the legislationgoverning the investment manager exemption (IME).

This covers two issues identified as part of the earlierconsultation process which could not be fully addressed inthe updated Statement of Practice SP1/01. Both these issueswere discussed at a meeting between HMRC and industrybodies in August as part of a consultation exercise by HMRC.At this stage it had doubts as to whether it would be able toget these changes enacted in Finance Act 2008, so the factthat it has announced them in the PBR should be taken asfurther evidence of its commitment to supporting the UKinvestment management industry.

The changes being proposed are:

1 The definition of investment transaction be amendedto align it more closely with the FSA definition ofregulated activities.

This was one of two options discussed with industrybodies, the other alternative being that all transactions

were covered unless specifically excluded. On balance itwas felt that aligning the definition with that of the FSAwould reduce the compliance burden and provided greatercertainty for companies whilst avoiding the complexitiesaround drafting legislation to exclude specific transactions.

At the same time it was acknowledged that some activitieswhich currently fall within the scope of the investmentmanager exemption would not be covered by thisapproach because they are not regulated activities.One example of this would be carbon credits. Equally,there are still assets such as land and commodities whichHMRC would want to ensure remain excluded for policyreasons. It can therefore be anticipated that the current listof specific exclusions will remain in place once thelegislation is enacted but, equally, that additionaltransactions which are permitted for tax purposes will beadded to the list.






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The key group of managers who wouldhave difficulties meeting either test would bemanagers who managed a single fund.

2 The removal of the ‘cliff edge’ test, whereby if a singlenon-investment transaction is entered into by a UKinvestment manager on behalf of the non-resident fund thefund could be considered to have failed the IME.

HMRC tried to address this issue in the updated Statementof Practice to provide an interim solution for non-residentfunds which were faced with this position. However, it wasalways understood that changes to the primary legislationwere required to provide certainty for fund managers.

The discussions with HMRC went wider than this point andincluded consideration of the impact of failing theindependent capacity condition. The debate in this areafocused around the risk that a manager did not meet therequirements of the IME and in addition could not availitself of the more general protection afforded by Section148(3) Finance Act 2003 which prevents a non-residentfund from creating a taxable presence in the UK if it carries

on business in the UK through an agent of independentstatus. The key group of managers who would havedifficulties meeting either test would be managers whomanaged a single fund. Given that no proposals wereannounced to address this, it still remains an area ofuncertainty, although doubtless there will be furtherdiscussions between HMRC and industry bodies in relationto this and the definition of investment transactions overthe coming months.







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Changes to rules for claimingno UK tax residenceThe deadline of 31 January 2008 for submittingthis year’s self-assessment tax return (2006/07)is fast approaching.

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Changes to rules for claimingno UK tax tesidenceThe deadline of 31 January 2008 for submittingthis year’s self-assessment tax return (2006/07)is fast approaching.

If you have overseas interests, you will notice that thereturn contains a number of changes to the non-residencepages. HMRC now requires more detail, probably becauseof such decisions in the Robert Gaines-Cooper case (seearticle in the previous edition of Rain or Shine), whichchallenged the accepted view of HMRC’s approach on certainresidency issues.

If your tax affairs are such that you are required to completethe non-residence supplementary pages, HMRC now tries toascertain the exact circumstances of your travellingarrangements, when claiming to be non-resident for taxpurposes. HMRC has specifically added new questions togather sufficient information for it to determine whethertaxpayers are applying their guidance in form IR20 correctly.

Some of the questions in the supplementary pages to thereturn, particularly within the section ‘Time spent in the UK’and the accompanying notes, are not completely clear.

This could easily lead to confusion and incorrect disclosure ifapplied without consultation of the law and full considerationof the facts.

The Chancellor’s Pre-Budget Report (PBR) 2007 made furtherchanges in his review of residence for UK tax purposes.In line with the approach we have seen in recent case law,HMRC will introduce rules to ensure that, after 6 April 2008,days of arrival and departure will be counted as days ofpresence in the UK for residence test purposes.

If you are a frequent traveller to the UK but claimingnon-resident status in the UK, the above-proposed changesin the PBR 2007 may affect your personal tax planning.Therefore, timely consideration is required if you would like tomaintain non-resident status.



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The member firms of the PricewaterhouseCoopers network provide industry-focused assurance, tax and advisory services to build public trust and enhance value for its clients and theirstakeholders. More than 146,000 people in 150 countries across our network share their thinking, experience and solutions to develop fresh perspectives and practical advice.

This report is produced by experts in their particular field at PricewaterhouseCoopers, to review important issues affecting the financial services industry. It has been prepared for generalguidance on matters of interest only, and is not intended to provide specific advice on any matter, nor is it intended to be comprehensive. No representation or warranty (express or implied) isgiven as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers firms do not accept or assume anyliability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decisionbased on it. If specific advice is required, or if you wish to receive further information on any matters referred to in this paper, please speak with your usual contact at PricewaterhouseCoopersor those listed in this publication.

© 2007 PricewaterhouseCoopers. All rights reserved. PricewaterhouseCoopers refers to the network of member firms of PricewaterhouseCoopers International Limited, each of which is aseparate and independent legal entity.

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UK Hedge Funds Electrnic Newsletter

Economy & Finance