On 25 March 2013 HMRC published Revenue & Customs Brief 04/13 providing guidance with regard to their view on the tax treatment of payments of ‘trail commission’ on investment products in the UK.
The move was intended to clarify existing legislation rather than introduce a new regime, but for many, the move raised more questions than it answered, creating some unintended consequences in the meantime.
The announcement stated that certain trail commissions passed on to investors as rebates in collective investment schemes and other investment products could be considered to be annual payments subject to income tax. As such HMRC would expect that under existing legislation where located in the UK those entities paying the rebates would deduct basic rate tax at source and investors would include such payments in self-assessment returns for 2013/14 onwards. HMRC has invited comments on its draft guidance by 30 June 2013.
Arrangements whereby all or part of any trail commission is paid by a UK fund manager to an investor, either directly or via other intermediaries who use it to meet the liabilities of, or provide a benefit to the investor, could impose a withholding tax requirement on the UK fund manager. This typically happens as a result of an agreement between the investor and the fund platform, although it could be as a result of an agreement between the investor and their adviser or the fund manager. Such payments usually originate from the annual management charge paid by the collective investment scheme to the fund manager.
HMRC states that there has been a misconception by some in the industry that such payments are not taxable in the hands of the investor and no withholding tax requirement existed, however this is not HMRC’s interpretation. They have confirmed that they will not seek to collect withholding tax on past payments from those arising before 6 April 2013, however, thereafter they consider that where payments fall within the definition of an annual payment a fund manager should be withholding basic rate tax.
Case law has established four essential characteristics for a payment to be an annual payment:
- The amounts must be paid under a legal obligation;
- The payments must be capable of recurrence;
- The payments must be income, as opposed to capital, in the hands of the investor; and
- The payments must represent ‘pure income profit’ of the recipient.
HMRC argues that trail commissions meet each of these characteristics of annual payments and therefore a withholding tax requirement exists. Industry bodies, such as AIMA and the IMA, have engaged in discussions with HMRC on whether the payments made under such arrangements constitute a ‘pure income profit’ i.e. they come to the recipient without them having to do anything in return.
HMRC has stated that they recognize that payers will need to make new arrangements to allow them to deduct basic rate Income Tax from such payments and accept that this may not be possible for payments made at the start of the tax year commencing 6 April 2013. To allow for this short implementation period HMRC will accept an approximation of the tax deducted at source up to the end of the calendar year 2013 providing that this is as accurate as reasonably possible and that the payer makes arrangements to update systems by the end of 2013.
A significant point of concern raised within the industry was that the proposed legislation could inadvertently affect non-UK resident investors in an offshore fund to whom a fee rebate is paid by a UK manager. This arises as the territorial scope of the annual payments legislation imposes a withholding tax requirement where the payments are deemed to be UK source income. In a written ministerial statement made on 21 May 2013 the Economic Secretary to the Treasury recognized this error. In their statement the Government agreed that by imposing a requirement to withhold tax for offshore investors could have negative implications on the international competitiveness on the UK funds industry and that the legislation would therefore have to be amended. Given that this release has run parallel to the Government’s recent launch of the UK’s investment management strategy we would hope for greater consultation and forethought in the future.
To rectify the issue, the Government published two draft statutory instruments on 29 May to remove the duty to withhold tax from rebates where these payments are made to investors who are not UK resident for tax purposes. Responses are requested on the draft instruments by 25 June. Although the drafts have no prescribed date to come into force, they do appear to have effect for the tax year 2013/14 onwards suggesting they apply from 6 April 2013. This will be a welcome move if it removes an interim period of doubt, as is hoped, which would otherwise arise from 6 April 2013 when the instruments are enacted.
In any case, UK based fund managers should review their contractual agreements and seek advice on how they may need to implement a withholding regime for UK investors or restructure their affairs in light of the proposed legislation.