Political and regulatory news
Issue 5 - 14 December 09
Reforming tax rules for investment trusts
The AIC is calling for a more commercially flexible tax regime for investment trusts.
The tax regime applied to investment trusts has been in place since 1965 and is showing signs of being inappropriate for today’s commercial environment. Based around seven tests which must be passed on an annual basis, the rules enable investment trusts to obtain certain tax benefits which prevent their shareholders from being taxed twice, once within the company and again when their shares are sold. However, in some cases, the tests are restricting what an investment trust can do commercially. The AIC is keen to establish if these distortive effects can be removed while still delivering the Government’s agenda that only suitable investment vehicles should be able to secure investment trust status.
The AIC is in talks with HM Treasury and HM Revenue & Customs to modernise ‘Section 842’, the section of tax regulation which contains the investment trust rules. For example, it is asking for two of the seven tests to be replaced by a more flexible approach. The ‘income test’, which requires income generated by an investment trust to come ‘wholly or mainly’ from shares and securities, and the ‘15% holding’ test, which limits the amount that an investment trust can invest in a single company, can be restrictive. Nowadays, investment trusts have access to a far wider range of assets than shares and securities, and there is no reason why their investment remit should be limited by the type of income they must earn. Whilst diversification is important, this is a matter for regulators rather than the tax authorities. A prescriptive limit on the maximum amount an investment trust can hold in a single company is also out of line with current regulatory practice, with the Listing Rules having dropped its limit some years ago.
The AIC is proposing that these tests are replaced with a ‘characteristics based’ definition which an investment trust must meet as part of its tax compliance. Precisely how this would be done is still the subject of discussions, but options might include a requirement for the company to raise money from a broad range of investors, for it to invest and manage a diversified portfolio of assets in order to spread investment risk, and for investors to benefit from the returns which are generated. An investment trust could then meet these more general conditions rather than the rigid income and investment tests.
The AIC is also seeking changes which would mean that trusts would not lose their tax benefits because of minor or unavoidable breaches of the rules. Similar provisions are already in place for VCTs and REITS and extending this to investment trusts would bring them into line with practice in other areas.
There is no guarantee that these changes will be deliverable, but the AIC is keen to put these issues on the agenda. Delivering these proposals over the next 12 months is unlikely as the Finance Bill process is likely to be dominated by other issues in an election year. However, the AIC is keen to prepare the ground for change once political circumstances permit.
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