Seven deadly sins of joint ventures under competition law
Joint ventures in the energy and resources sectors.
The introduction of the PRIIPS regime on 1 January 2018 has been problematic to say the least, particularly for alternative investment funds which have their shares listed on the London Stock Exchange, with many managers, boards and commentators expressing strong concerns that the formulaic disclosure requirements risk forcing PRIIPs manufacturers to issue a document that risks being misleading to investors.
As a response to these criticisms, the FCA issued a statement on 24 January 2018 as follows:
"Where a PRIIPs manufacturer is concerned that performance scenarios in their KID are too optimistic, such that they may mislead investors, we are comfortable with them providing explanatory materials to put the calculation in context and to set out their concerns for investors to consider.
Where firms selling or advising on PRIIPs have concerns that the performance scenarios in a particular KID may mislead their clients, they should consider how to address this, for example by providing additional explanation as part of their communications with clients."
Manufacturers and advisers who have such concerns should be considering whether to provide such additional explanatory material. Particular areas of concern include disclosure of costs and expenses, performance scenarios and risk indicators.
In the absence of detailed guidance, it appears that the manner in which different PRIIPs manufacturers have calculated disclosure of costs and expenses is highly inconsistent. For example, whether or not to take account of transfer taxes, finance costs and performance fees. Estimates of portfolio transaction costs appear to vary widely between similar mandates.
In respect of the required disclosure of performance scenarios, the KID is not allowed to include historic returns. Instead, an illustration of the potential return under four performance scenarios (stress, unfavourable, moderate and favourable) are required to be included modelled over one, three and five years. However, these scenarios are inherently based on share price returns over the previous five years. At present, that means modelling them based on a particular market period that has seen strong market growth, narrowing discounts and falling volatility, which may possibly prove very different from the subsequent five year period. Funds that do not have sufficient share price data must create a model based on an appropriate market benchmark, which is not straight forward for asset classes like infrastructure and specialist real estate and may well be unreflective of likely share price performance or others in the peer group.
The methodology required to be followed for calculating a fund’s summary risk indicators (from 1 (very low) to 7 (very high)) requires traded funds to take account of the volatility of their share price. However, as some market commentators have pointed out, low historic volatility might be a reflection of a lack of liquidity rather than low risk and mean that certain funds are publishing a lower risk indicator that might be appropriate.
Following last November's budget, HM Treasury and HMRC have published a consultation document on taxing gains made by non-residents investing directly or indirectly in UK property.
Currently, non-resident investors disposing of their UK non-residential property are not subject to UK tax on their chargeable gains. Neither does the UK tax widely-held non-resident companies on disposals of interests in residential UK property held as an investment, nor seek to tax disposals of entities that derive their value predominantly from UK property held as an investment. The proposals therefore represent a significant change to the rules for taxing chargeable gains on UK property which have been in place for decades. As a result, real estate managers are analysing their existing UK real estate funds and holding structures to determine what steps may be required to mitigate the effects of the new regime.
With respect to non-residential property, only the gains attributable to changes in value from 1 April 2019 (for companies) or 6 April 2019 (for other persons) will be chargeable, which will be achieved by rebasing property values at April 2019. April 2019 will also be the rebasing point for widely held, non-resident companies on all disposals of interests in UK property and for all persons on all indirect interests.
As far as funds and holding entities are concerned, the new chargeable gains regime applies to "property rich” entities but will not apply to interests held by tax exempt entities or any entity in which a taxable investor has less than a 25% interest in the last five years before sale. Holdings are aggregated for this purpose and the ownership test is backward looking throughout the period rather than simply at the time of the disposal.
An entity will be considered “property rich” where, at the time of disposal, directly or indirectly, 75% or more of the value of the asset disposed derives from UK property. The test will be made on the gross asset value of the entity, so not including liabilities such as loan finance. The test will use the market value of the property at the time of disposal. For the purposes of establishing whether this 75% test is met all UK land held in the entity will be taken into account, i.e. both residential and non-residential property. Non-UK land will not count towards the 75%. The disposal may be directly of the interest in the property rich entity, or of a holding company or similar with a structure of entities beneath it which, taken together meet the property richness test. Where it is necessary to trace value, the government has stated that the rules will allow this to be done through layers of ownership, through entities, trusts or other arrangements to arrive at a just and reasonable attribution of value.
It may still be possible to rely on certain double tax treaties, particularly Luxembourg, which grant it taxing rights over the property holding entity to such other jurisdiction, so that such gains cannot also be taxed in the UK. However, the new legislation will contain an anti-forestalling rule, which will apply to certain arrangements entered into on or after the publication of the consultation document on 22 November 2017. The rule will counteract arrangements that seek to avoid this tax on non-residents by exploiting provisions in some tax treaties in a way that is contrary to the object and purpose of the new change to capital gains tax, which may particularly constrain the ability to rely on certain treaties such as Luxembourg’s. Details of the anti-forestalling measures are set out in a Technical Note published alongside the consultation.
The common use of Jersey property unit trusts (JPUTs) as holding entities or funds for UK real estate is particularly vulnerable to this legislation, since the JPUT has an unusual tax status in the UK being able to be transparent for income but opaque for chargeable gains. The application of the new rules to JPUTs is particularly uncertain.
Managers should certainly be reviewing existing holding structures to determine whether their tax treatment will change from March 2019. If so, it may be that it is still more attractive to sell the shares or units in the entity than to collapse it or try to restructure, although this will depend on the likely rebased value in March 2019 and the expected holding period and the tax status of the investors. We expect new funds and holding structures to make much use of the exemptions for tax exempt investors and taxable investors holding less than a 25% interest. However, existing funds structured as JPUTs seeking new capital face great uncertainty and we are likely to see some restructure during the course of this year.
Joint ventures in the energy and resources sectors.