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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 article can be downloaded in pdf format at Academia.edu)

Why does this matter?

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.

What are unit trusts? And what are OEICs?

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).

Authorised Investment Funds - unit trusts and OEICs2

How are unit trusts and OEICs taxed?

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:

  • Firstly, they benefit from the tax exemption from capital gains, along with other fund vehicles such as investment trusts, VCTs and REITs2;
  • Secondly, they are subject to corporation tax on their income profits at 20%3 – this used to be a special rate when the main corporate rate was at around 30% or even higher. However, as we shall see, this special rate has gradually become less and less special.

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:

  • A unit trust investing primarily in equities doesn’t pay tax on most dividends, since these are exempt for all corporate investors4;
  • Tax is payable on other types of security such as debt instruments and derivatives. However:
  • Unit trusts that invest primarily in debt – also known as “bond funds” – are able to deduct the amount of distributions paid to investors against their interest receipts5. Since unit trusts are required to distribute all their income, the one balances the other and so the tax payable on debt securities is effectively nil;
  • Alternatively a unit trust that doesn’t qualify for bond fund treatment can apply for tax elected status. This allows it to stream its income between different sources. All equity dividends are exempt as usual, and to the extent that a shareholder distribution is paid from other sources, it is treated as a tax deductible interest payment6;
  • Property authorised investment funds pay no corporation tax on property investment income7;
  • Finally, all unit trusts can treat management expenses as a deduction against taxable profits8.

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.

A short history of how the legislation has taxed unit trusts in the past

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:

  • Until 2006/07, they were taxed at the then lower rate of income tax – which happened to be 20%9;
  • In 2007/08 the lower rate of income tax was abolished and the savings rate was introduced. The legislation for unit trusts was amended so that unit trusts were taxed at the new savings rate – which happened to be 20%10;
  • In 2008/09, the savings rate was abolished, and since then unit trusts have been taxed at the basic rate of income tax in force at the time – which has always stayed at 20%11.

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.

How are authorised investment funds taxed-001

What is happening to the authorised funds rate, now that the main corporate rate is coming down to 18%?

We need to look at what the Finance Bill 2015-16 says. We are told that12:

  • For the financial years 2017, 2018 and 2019 the main rate of corporation tax is 19%; and
  • For the financial year 2020 the main rate of corporation tax is 18%.

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.

Satwaki Chanda

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.

Kind regards

Ellen [Milner]

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 has also been published at world.tax. world.tax is the unique knowledge centre, providing online tools for comparing tax jurisdictions around the world.


 

  1. CTA 2010 s 617 for taxation of income, and TCGA 1992 s 99 for capital gains.
  2. TCGA 1992 s 100, Authorised Investment Fund Regulations 2006/964 (“AIF Regulations) reg 100
  3. CTA 2010 s 614.
  4. CTA 2009 Part 9A Chapters 2, 3.
  5. AIF Regulations, regs 13, 18-21.
  6. AIF Regulations, regs 13, 69Z61.
  7. AIF Regulations, reg 69C(3), 69F, 69Y(1).
  8. CTA 2009, s 1219(1).
  9. ICTA 1988 ss 1A(1B), 468(1A).
  10. ITA 2007 s 7, introducing the savings rate of 20%. Lower rate abolished by ITA 2007 Schedule 1, paragraph 2. Corporate tax rate for unit trusts and OEICs amended to savings rate by ITA 2007 Schedule 1, paragraphs 85(2), 86, amending ICTA 1988 s 468(1A).
  11. Savings rate abolished by FA 2008 s 5. Unit trusts and OEICs subject to corporation tax at the basic rate under ICTA 1988 s 468(1A), as amended by FA 2008 Schedule 1, paragraphs 41, 42. From 2010, ICTA 1988 s 468(1A) replaced by CTA 2010 s 614. The basic rate of income tax from 2008/09 has been set at 20% by FA 2008-2011, 2014-15 s 1(2)(a) and FA 2012 ss 1(1)(a), 1(2)(a).
  12. FB 2015-16 Cl 7.
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Satwaki Chanda

Satwaki Chanda

Satwaki Chanda is a tax lawyer with a First Class degree in Mathematics. Called to the Bar in 1992, he is the Editor of Tax Notes.
Satwaki Chanda

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