Regulation and tax treatment for property funds

The beleaguered fund management group put the brakes on savers withdrawing their cash after a number of institutional investors cashed in their investments, leaving the portfolio with insufficient cash reserves.

The headlines created by New Star’s decision prompted calls for a re-think of regulation of property funds.

Chris Ludlam, head of real estate capital for Schroder Property Investment Management, says UK regulations today fully recognise the different characteristics of property as an asset class to those of securities markets - particularly its illiquidity.

While seeking to ensure investors are able to invest and, most importantly, disinvest in a timely manner, Mr Ludlam says regulations provide for fund managers to offer less frequent dealing than in securities funds.

He says: “Requirements in the funds market tend to drive most funds to offer daily dealing. Fund sponsors have to ensure they have sufficient liquidity to meet investors’ demands and, for the most part, the funds available in the market place have done this successfully.

“In the unprecedented turmoil of the global financial crisis it is no surprise that some funds experienced liquidity problems and this serves as a reminder of the tension that exists in a daily dealt fund holding bricks and mortar, and the importance of very careful management of liquidity.”

While governing bodies, such as the FCA, are in the process of harmonising the regulation and supervision of commercial property funds, the regulatory framework around property funds can depend on the type of investment vehicle used.

In practice, Mr Ludlam says today the UK’s financial regulator, the Financial Conduct Authority, only permits retail investors to invest in frequently dealt property funds, alongside shares in listed property companies.

Ainslie McLennan, manager of Henderson UK Property Oeic, says investors should ensure they get appropriate advice on what type of investment is suitable for them before putting their money to work.

Tax

As well as regulation varying, investors can find the tax treatment on property funds will vary depending on which property vehicle a consumer selects and how they choose to invest their money.

Retail investors in directly invested property funds will typically be subject to corporation tax deducted from the gross income distribution, says Schroder’s Mr Ludlam.

He says this is true whether the fund is structured as an authorised unit trust or a property authorised investment fund (Paif). Corporation tax is currently withheld at the rate of 20 per cent.

Investors in funds which invest in property securities funds domiciled in the UK will be subject to income tax withheld on distribution payments at the basic rate (currently also 20 per cent), he adds.

Mr Ludlam says: “It is worth noting that certain categories of investors are able to receive income distributions gross of tax. However, this is limited to so-called exempt investors such as UK pension funds and charities.

“Investors through Sipps may also be able to benefit from this, though the minimum investment for these professional investor funds may be £100,000 or more.”

On Sipps, draft regulations on capital adequacy had initially classified commercial property as a ‘non-mainstream’ investment and thus the ‘cost of capital’ for providers would have substantially increased, leading potentially to fewer providers offering the option and costs increasing.

Regulations were eventually changed, however, and commercial property was re-classified as mainstream. Perhaps this will serve as a warning, however, that the regulator is still looking at liquidity issues around property and changes may yet come in the longer term.