UK Property Authorised Investment FundsTime for another look?

SummaryA 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. 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.

1UK Property Authorised Investment Funds Time for another look?

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)

Why form or convert to a PAIF?The relatively stable, income returns to be generated from good quality investment property are increasingly attractive to investors. Additionally, the perception of the UK as a safe haven has increased demand for UK focused property investment products.

The PAIF vehicle provides a tax efficient, property investment vehicle which is well regulated. Its status as an open ended investment vehicle provides investor liquidity in an alternative form to UK REITs, which share many of the same tax advantages.

Regulatory environment: the increase in PAIF launches over the last 12 months has largely been driven by changes to the regulatory environment. In particular, the Retail Distribution Review has required unauthorised funds to consider becoming authorised. This, along with EU measures such as AIFMD, may provide increased comfort to investors concerned over security of investment.

Tax efficiency: traditional property fund 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.

Liquidity: open-ended funds have faced practical issues in managing investor redemptions, but the ability of PAIFs to hold REIT shares in a tax efficient manner alongside real property may provide fund managers with the ability to hold a proportion of the fund’s investment portfolio in a more liquid form, to meet investor redemptions, whilst reflecting (indirect) property returns in fund performance.

Simpler conversion: tax legislation and practical issues have been ironed out, such that there should be no tax implications for investors when converting to a PAIF.

Marketing: the regulated nature of the PAIF means that it can be widely marketed to most investors, particularly to retail investors, that may not be able to access other property investment vehicles. Although greater awareness of investment products by promoters is required, this will also lead to improved internal processes and information flow.

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:

Structural requirementsA PAIF must be structured as an OEIC. By definition it must be registered with the FCA and qualify as an Authorised Investment Fund.

The PAIF must satisfy the Genuine Diversity of Ownership condition: investment must be open to a wide range of investors, with no undue restrictions applying.

Tax penalties may be imposed if there is direct investment in the PAIF of 10% or more by any single corporate investor, although most PAIFs will have a dedicated feeder fund to enable larger corporate investors to invest indirectly without penalty.

Business activity requirements of a PAIFThe predominant activity of a PAIF must be UK or 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).

The PAIF must not be party to loans that provide loan creditors with an interest return linked to profits, or the value of assets. Debt finance restrictions apply according to the PAIF’s regulatory status and where it is a Qualified Investor Scheme (QIS), a profits/financing costs ratio restricts the level of interest deductions available.

Distribution requirements Income from property investment activities is distributed to investors annually in the form of a Property Income Distribution (PID) which is subject to tax in the hands of investors as rental income. Other income will be distributed either in the form of a taxable interest distribution or as a normal corporate dividend.

Capital gains are generally not distributable by PAIFs and investors will need to redeem shares in the PAIF to realise the underlying capital growth.

3UK Property Authorised Investment Funds Time for another look?

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 advice to ensure the smooth transition to establishing and operating as a PAIF (or other chosen property investment fund vehicle).

EY can assist:

► Managers who are planning to launch new property funds.

► Managers of existing traditional structures (such as limited partnership or unit trust structures) who are seeking to market the fund more widely.

Through experience gained from advising on the implementation of a wide range of onshore and offshore, open-ended and closed-ended structures, EY can help managers select the most appropriate structure according to the profile of investors and business plans for their funds. A PAIF structure may meet the commercial requirements of the fund manager by providing a platform that is capable of being marketed to a wider audience of investors and meeting investors requirements for investment liquidity and tax efficiency and offering the protection afforded by a regulated environment.

EY can also support fund managers in a number of other ways as outlined overleaf, including advising on the tax efficient reorganisation of existing structures and the implementation of management processes in preparation for launch and operation as a more widely marketed fund.

Case study To illustrate how EY can help, a recent project is summarised below:

Situation: the fund manager of an unauthorised unit trust, holding both direct and indirect investments in residential property, recognised the structure was no longer fit for purposes in the light of the Retail Distribution Review (RDA) and the ban on promotion of unregulated collective schemes to ordinary retail investors

Solution: authorisation was obtained from the FCA for the unit trust to become authorised. The trust then converted to an authorised OEIC and notified HMRC of its intention to join the PAIF regime.

Benefits: we supported the fund by advising on a tax strategy for restructuring all its assets into direct ownership and the conversion of the trust to an OEIC enabling it to satisfy the PAIF conditions at no tax cost for investors. We also carried out tax due diligence on the fund and advised on steps to achieve ongoing compliance and preserve tax efficiency, including the implementation of a feeder fund for corporate investors and producing operating guidelines for the manager.

4 UK Property Authorised Investment Funds Time for another look?

► Restructuring advice

► Stamp Duty Land Tax advice/compliance

► Feeder fund structuring

► PAIF regime compliance

► Designing internal controls

► Corporate governance issues

► Due diligence

► Investor sourcing

► Production of prospectus, circular etc.

► Financing issues

► Reporting accountant advisory

Becoming a PAIF

► Pros and cons of PAIF structure

► Comparison against other property vehicles

► Financial and business modelling

► Cost-benefit analysis

► Advice on regulatory requirements

► Investor profile analysis

► Potential to comply with PAIF conditions

Is it right for you?

► Audit services

► Tax services

► Business advisory services

► Valuation services

► Shareholder distribution advice

► Global assignment tracking and reminder facilities

► Debt/corporate finance advisory

► Property acquisitions/disposals

► Tax compliance including monitoring

► Due diligence for future property transactions

► Liaising with HMRC to enhance regime

Life as a PAIF

Assisting you at all stages

5UK Property Authorised Investment Funds Time for another look?

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Contacts

Dean HodcroftUK&I Head of Real Estate

T: + 44 20 7951 4870 E: dhodcroft@uk.ey.com

Peter AmesPartner

T: + 44 131 777 2262 E: pames@uk.ey.com

Marion CaneExecutive Director

T: + 44 20 7951 5795 E: mcane@uk.ey.com

Stuart Chalcraft Associate Partner

T: + 44 20 7951 1190 E: schalcraft@uk.ey.com