UK Property Authorised Investment Funds - EY

1 UK Property Authorised Investment Funds Time for another look? Summary A Property Authorised Investment fund (PAIF) is a tax efficient, UK. regulated Property fund vehicle, which provides investors with an open-ended alternative to listed UK REITs and other fund vehicles, as a means of accessing returns from professionally managed real estate portfolios. Originally introduced in 2006, take-up has been relatively slow, but a raft of regulatory changes affecting more traditional unregulated Funds in the last 12 months has led to renewed interest in this structure. A number of fund launches have followed and more are in the pipeline. The regime provides for UK tax exemption of Property rental profits and other Investment income, provided income is fully distributed to investors.

2 In addition, due to the requirement for the PAIF to be Authorised by the Financial Conduct Authority (FCA), no tax is charged on capital gains generated. There should be no taxation of Property profits at the fund level, but investors will be taxed on the income generated as if they had invested in real Property directly. A further benefit is that a PAIF can hold UK and overseas REIT shares as well as direct real Property , helping fund managers manage investor redemptions whilst ensuring fund performance only reflects Property Investment returns. This note is intended to give an overview of the regime, and the potential benefits to investors, and explains how EY can provide advice and support for your PAIF launch or conversion.

3 Key features of a PAIF: An Authorised Investment fund primarily invested in Property No UK tax at fund level on income and gains generated by fund Income taxed at shareholder level on annual distributions To qualify, the fund must: Be established as an Open Ended Investment Company (OEIC). Meet the Genuine Diversity of Ownership condition Comply with Corporate Ownership restrictions Directly invest in real Property and REIT shares, that account for at least 60% annual fund profits and at least 60% total fund assets Observe loan creditor and borrowing restrictions Withhold tax from distributions to investors (except pensions Funds , charities and certain others). UK Property Authorised Investment Funds Time for another look?

4 1. Why form or convert to a PAIF? The relatively stable, income returns to be Liquidity: open-ended Funds have faced generated from good quality Investment practical issues in managing investor Property are increasingly attractive to redemptions, but the ability of PAIFs to hold investors. Additionally, the perception of the UK REIT shares in a tax efficient manner alongside as a safe haven has increased demand for UK real Property may provide fund managers focused Property Investment products. with the ability to hold a proportion of the fund 's Investment portfolio in a more liquid The PAIF vehicle provides a tax efficient, form, to meet investor redemptions, whilst Property Investment vehicle which is well reflecting (indirect) Property returns in regulated.

5 Its status as an open ended fund performance. Investment vehicle provides investor liquidity in an alternative form to UK REITs, which share Simpler conversion: tax legislation and many of the same tax advantages. practical issues have been ironed out, such that there should be no tax implications for Regulatory environment: the increase investors when converting to a PAIF. in PAIF launches over the last 12 months has largely been driven by changes to the Marketing: the regulated nature of the regulatory environment. In particular, the Retail PAIF means that it can be widely marketed Distribution Review has required unauthorised to most investors, particularly to retail Funds to consider becoming Authorised .

6 Investors, that may not be able to access This, along with EU measures such as AIFMD, other Property Investment vehicles. Although may provide increased comfort to investors greater awareness of Investment products concerned over security of Investment . by promoters is required, this will also lead to improved internal processes and Tax efficiency: traditional Property fund information flow. structures may no longer meet the varying needs of all investors or their advisors. Coupled with the tax efficient nature of a PAIF, the regime is becoming the obvious structure for sponsors of open ended Property Investment Funds . The regime provides a tax efficient Investment vehicle where there is a wide range of investors.

7 2 UK Property Authorised Investment Funds Time for another look? Overview main qualifying criteria The PAIF regime imposes a number of particular conditions on the structure and activities of a PAIF. These are summarised below: The PAIF must not be party to loans that provide Structural requirements loan creditors with an interest return linked A PAIF must be structured as an OEIC. By to profits, or the value of assets. Debt finance definition it must be registered with the FCA and restrictions apply according to the PAIF's qualify as an Authorised Investment fund . regulatory status and where it is a Qualified The PAIF must satisfy the Genuine Diversity Investor Scheme (QIS), a profits/financing of Ownership condition: Investment must be costs ratio restricts the level of interest open to a wide range of investors, with no undue deductions available.

8 Restrictions applying. Tax penalties may be imposed if there is direct Distribution requirements Investment in the PAIF of 10% or more by any Income from Property Investment activities is single corporate investor, although most PAIFs distributed to investors annually in the form of will have a dedicated feeder fund to enable a Property Income Distribution (PID) which is larger corporate investors to invest indirectly subject to tax in the hands of investors as rental without penalty. income. Other income will be distributed either in the form of a taxable interest distribution or as a normal corporate dividend. Business activity requirements of a PAIF Capital gains are generally not distributable by PAIFs and investors will need to redeem shares in The predominant activity of a PAIF must be UK or the PAIF to realise the underlying capital growth.

9 Non-UK direct Property Investment or holding shares in UK and non-UK REITs. This Investment intention is tested annually through Balance of Business Income and Asset tests that require at least 60% of the income and assets to be generated from Property Investment (relaxed to 40% in the PAIF's first accounting period). UK Property Authorised Investment Funds Time for another look? 3. How can EY support? EY has first-hand experience of guiding clients through the process of launching a PAIF and can provide wide-ranging support throughout the process. This includes advising on the choice of structure and preparation for launch, as well as a seamless transition into the operating phase. Our real estate and Funds professionals are able to provide extensive and collaborative Case study advice to ensure the smooth transition to To illustrate how EY can help, a recent project establishing and operating as a PAIF (or other is summarised below: chosen Property Investment fund vehicle).

10 Situation: the fund manager of an unauthorised unit trust, holding both direct EY can assist: and indirect investments in residential Property , recognised the structure was no Managers who are planning to launch new longer fit for purposes in the light of the Property Funds . Retail Distribution Review (RDA) and the Managers of existing traditional structures ban on promotion of unregulated collective (such as limited partnership or unit trust schemes to ordinary retail investors structures) who are seeking to market the Solution: authorisation was obtained from the fund more widely. FCA for the unit trust to become Authorised . Through experience gained from advising on The trust then converted to an Authorised the implementation of a wide range of onshore OEIC and notified HMRC of its intention to join and offshore, open-ended and closed-ended the PAIF regime.