Sovereign Wealth Funds Consultation
FTI Consulting’s Response to UK Government’s Consultation on the Reform of Sovereign Immunity
October 10, 2022
Sovereign Wealth Funds Consultation
The UK Government’s consultation period on the reform of sovereign immunity from direct taxation closed on 12 September 2022, with FTI Consulting having been directly involved in discussions with the government and submitting a detailed consultation response.
The proposed changes
As part of the initial consultation document, the government proposed the following substantial changes to be implemented from April 2024:
- Sovereign immunity from all UK direct taxation will be removed and replaced with a limited sovereign exemption from UK tax for UK-source interest income, which will be administered via an exemption from the UK withholding tax (“WHT”).
- Consequently, sovereign persons’ income and gains from UK immovable property and income from UK trading activity will be brought into tax. In particular:
There will be UK tax on rental profits and gains if investing directly (e.g. through a Jersey Property Unit Trust or partnership).
There will be no exemption on UK Real Estate Investment Trust (“REIT”) distributions, so full UK WHT will apply to property income distributions unless sovereign persons invest through a taxable subsidiary and fragment their interest to less than 10% in each.
There will no exemption on the sale of shares in UK property-rich entities.
There will be no exemption on distributions from exempt elected funds.
- For capital gains purposes, assets held by sovereign persons (either directly or through tax-transparent entities) will be rebased to their market value at the date of commencement such that only economic gains after commencement will be subject to UK tax.
- UK tax reporting and payment requirements will apply to sovereign persons — such persons will be required to register for UK taxes, file UK tax returns and make payments of UK income tax or corporation tax (as applicable) for the first time.
- The principles of sovereign immunity will be comprehensively set out in legislation to provide greater clarity and certainty, and immunity will be available only following approval of a formal online application to HM Revenue & Customs (“HMRC”).
- Although the impact of the qualifying investor status of sovereign wealth funds (“SWFs”) (i.e. whether SWFs will continue to be “good investors”) for the purposes of meeting the conditions to qualify for other regimes such as UK REITs, qualifying asset holding companies (“QAHCs”), the substantial shareholding exemption for qualifying institutional investors (“QII SSE”) and the exemption election for collective investment vehicles will “need to be considered carefully”, no changes are currently proposed.
It is expected that draft legislation covering the proposed changes to the UK tax regime for sovereign persons will be released in the spring/summer of 2023 (although it is possible that the recent change in prime minister will result in a change in approach regarding the proposals).
The consultation document recognises that the UK has long benefitted from investment by SWFs and foreign public pension funds. It is therefore imperative that care is taken to ensure that the revised regime does not materially discourage sovereign investment in the UK.
We provided detailed responses to the government’s consultation. Our comments reflected that the proposals:
- Will not have been expected by sovereign persons (i.e. there has been no publicised indication that this is something the government has been considering).
- Are intended to create a “level playing field” with equivalent sovereign immunity regimes in other jurisdictions, but given the extent of the proposals, the government may make the UK less competitive if implemented as currently envisaged.
- Come at a time when the UK faces significant economic headwinds, macroeconomic uncertainty and a need to comply with climate change commitments (with the submission being written before the recent mini “budget” and the following currency devaluation).
- Follow a number of recent legislative changes — both to UK taxation, particularly the taxation of UK land, and outside taxation (e.g. “Brexit”) — that have the potential to undermine the UK’s attractiveness and stability as a location in which to invest.
- Create additional tax compliance obligations that sovereign persons may encounter practical difficulties complying with and will put additional strain on HMRC resources and systems.
Our primary recommendations were as follows:
- To postpone the date of implementation by at least a year to allow sufficient time for the design of the revised regime to be considered in detail (particularly how it interacts with other regimes such as REITs, QAHCs and the QII SSE, and for HMRC systems and resources to be suitably improved).
- To preserve QII SSE status (i) for non-UK investments and (ii) where the sovereign investor does not have a controlling interest.
- To allow for a rebasing of corporate structures (to account for QII SSE participation) where sovereign persons have a controlling interest.
There is a risk that the proposed sovereign reform could result in a significant reduction in sovereign investment in the UK and a rush to divest or at least restructure existing holdings, particularly if the reforms ultimately extend to a substantive change to the QII status of sovereign investors (to which we are opposed). Given the significant contribution SWFs make to UK real estate, this would have a profound impact on the market and could lead to depression of capital investment (much of which either provides a buyer of developments or finances those developments).
Joint venture partners and other stakeholders in structures in which SWFs have invested will need to be alert to the potential impacts, as will UK REITs that may have relied on sovereign investment to meet the close company condition.
Care will also be required in the structuring of new investments involving SWFs. We anticipate that if the reforms are implemented as currently proposed, SWFs are likely to continue to wish to invest via entities that provide a limitation of liability (e.g. limited partnerships and limited companies) for commercial and legal reasons. However, there is currently uncertainty as regards how sovereign persons will ultimately be defined and how broadly the new limited exemption from UK tax on UKsource interest income will apply; for instance, will companies that are wholly owned by SWFs qualify for the exemption or only the sovereign persons themselves?
Similarly, whilst the consultation refers to an intention that the “normal rules will generally apply”, there is uncertainty regarding how a number of areas of the corporation tax regime are intended to be applied to sovereign persons; for example, will a sovereign non-natural person fall within the definition of “company” for various tax purposes?
SWFs and their advisors will also need to prepare for the new tax compliance, valuation and reporting requirements. If the reforms are implemented as proposed in the consultation, sovereign persons will, at a minimum, need to:
- Instruct third-party valuations to support any rebasing of the UK property assets they hold.
- Make an online application for sovereign status.
- Register for UK income tax or corporation tax (as appropriate).
- File annual tax returns, which may include the submission of accounts tagged in iXBRL format.
- Make payments of tax on non-exempt profits and gains, potentially on an instalment basis.
Please get in touch with FTI.Tax@fticonsulting.com if you would like to discuss further the implications of these changes.