INTM561600 - Hybrids: special provision concerning transparent funds

Chapter 13A of Part 6A was introduced with effect from Royal Assent of the Finance Act 2021 to prevent hybrid counteractions arising in some cases involving funds where this would not otherwise be the case.

In the broadest sense, Chapter 13A prevents counteractions which would otherwise arise in respect of direct or indirect investors in transparent funds who hold less than 10% of those funds. Chapter 13A is only applicable where no structured arrangement is in place. It only has potential application to counteractions under chapters 3, 4, 5, 7 and 9. Section 259MB covers cases in Chapters 3, 4, 5 and 7, where a fund is a payee. Section 259MC covers Chapter 9, where a fund is an investor in a hybrid entity with the consequence that investors in the fund may potentially claim deductions in respect of amounts which have also given rise to relief in the hybrid entity.

Section 259MA defines a transparent fund as a Collective Investment Scheme or an Alternative Investment Fund which if, were all the income or profits to arise from UK sources, and were all the participants within the charge to income tax, the fund’s profits or income would be profits or income of its participators for the purposes of income tax.

In the event that there is a tier structure of funds (for instance because a fund’s investors include a fund of funds), both section 259MB and section 259MC apply the 10% test by reference to the fund which is furthest from the ultimate investors. For section 259MB this will be the fund that receives the payment which may give rise to a mismatch, while for section 259MC this will be the fund which directly owns the entity whose hybridity is essential to the potential double deduction (whether or not a deduction accrues in that entity or in a transparent or hybrid entity which that entity owns directly or indirectly).

Section 259MB asks whether a given opaque investor is entitled to less than 10% of the payment received by the fund, while section 259MC identifies the proportion of the hybrid entity’s total deduction which should be regarded as potentially arising to the fund and asks whether a given opaque investor is entitled to less than 10% of that. In each case, counteractions in respect of investors holding less than 10% are not made.

Both 10% tests contain a ‘reasonable to suppose’ element. They are met if it is reasonable to suppose that a given person with an interest in the fund is entitled to less than 10% of the amount being tested. The tests also both include an anti-fragmentation rule, requiring each relevant person’s interest to be aggregated with the interests of their connected persons. Where a new fund is being set up (or where a new investor puts money into an existing fund), the expectation is that confirmation will be sought by the fund’s promoters from incoming investors as to whether they have any connected persons also investing in the fund in order that the fund can make an informed judgment as to which investors may exceed the 10% threshold. However, in relation to funds already in existence when Chapter 13A came into force, this exercise could be onerous. A fund would therefore only be expected to seek further information as to connection to justify any reasonable supposition made in applying the 10% tests where there was positive reason to suspect a connection from information already held (for instance where a number of investors shared an address or registered office).

If a reasonable supposition is subsequently determined to be false, then Chapter 12 will operate in the usual way.