A tax change being introduced in January could lead to a surge in outflows from UK direct property funds, an analyst has warned.
In the 2019 Finance Act, the UK government introduced a provision whereby capital gains tax must be levied on the sale of commercial property in the UK, even if the beneficial owner is overseas.
Louis Tambe, fund analyst at FE Fund Info, said the already stricken property fund sector could be plunged further into trouble as the tax takes effect next month and could see investors rush to withdraw cash from the funds before the deadline. This could lead to substantial outflows and heightened risk of further fund suspensions.
He said: “A change in tax regulations around non-UK domiciled investors in UK property rich funds might become an issue should investors be forced to redeem holdings on the back of tax liabilities.
"Although the precise impact will be difficult to forecast, investors should be aware of the changes and take the necessary precautions."
Open-ended property funds are particularly vulnerable to client outflows because the underlying assets take time to sell.
Only last week M&G suspended dealing in its £2.5bn Property Portfolio fund due to the volume of outflows.
Days later it emerged that Prudential, whose £164m Prudential M&G Property Portfolio is fully invested in M&G’s fund, also suspended dealing in those funds.
The new rules mean that a property fund, even if registered offshore, would have to pay capital gains tax on any investment it sells.
The rule applies to all direct UK commercial property investments, and to UK open-ended funds that have 75 per cent or more invested in UK property - the term used by the legislation is "property rich funds."
Investment trusts that own direct property do not have to pay the tax, as there is an exemption for trusts listed on a major stock exchange.
The UK corporation tax rate of 19 per cent being paid out on investments would dent the returns generated by the fund for investors. The tax is to due be cut to 17 per cent in April.
In a note to advisers, published on its website when the law was introduced in April, Old Mutual International warned investors with a bond investment that is invested in a UK property fund would have to pay the capital gains tax if they sell the fund, despite the fact the investment is offshore.
It stated: "If your clients hold UK property rich funds through an offshore bond, then they are impacted.
"As the offshore bond provider is the legal and beneficial owner of the investments held within the bond, the funds will be deemed to be held by a non-UK resident."
It added: "Within an offshore bond, when an impacted property fund is sold, any gain on that fund since it was purchased (or since 6 April 2019 if purchased before this date) will be subject to tax. The offshore bond provider is liable for this tax and will pay any amount due to HMRC.
