IFM04340 - AIFs: Property authorised investment funds (PAIFs): tax treatment of PAIFs and distributions: charge to tax for distributions to holders of excessive rights

Charge to tax where distribution made to holder of excessive rights (regulation 69Z12 of SI 2006/964)

Where the PAIF has paid out a distribution to, or in respect of, a holder of excessive rights in the PAIF (that is, where there has been a breach of the corporate ownership condition – IFM04170) a charge to corporation tax is imposed on the residual business of the PAIF. The effect of this charge is to tax such part of the distribution as arises from the tax-exempt income of the PAIF.

The residual business of the PAIF is treated as having received an amount of chargeable income, calculated using the formula I x P%, where:

I is the net income of the tax-exempt business of the PAIF that is distributable, and

P is the percentage of the rights to the net asset value of the PAIF represented by shares held by (or on behalf of) the holder of excessive rights.

This sum is charged to corporation tax as if it were an additional part of the residual income of the PAIF (i.e. that part of its income not derived neither from the property investment business). No losses, deficits, expenses or allowances can be set off against the sum to be charged.

Meaning of ‘holder of excessive rights’ (regulation 69Z13 SI 2006/964)

A ‘holder of excessive rights’ means a corporate body investor of the PAIF that is beneficially entitled to shares representing rights to 10% or more of the net asset value of the PAIF.

Example of charge to tax

Open-ended investment company X is a PAIF with 100,000 shares in issue as at its accounting date of 31 December 2017.

Company Y owns 12,000 of the issued shares in X. X has total distributable income of £10,000 for the period ended 31 December 2017 (of which £7,000 is the net income of the tax-exempt business). X pays distributions in proportion to its shareholder’s rights on 15 February 2018.

Y is a holder of excessive rights because it holds 10% or more of the shares in the PAIF by net asset value (its holding is, in fact, 12%). Y’s beneficial entitlement to dividends is 12% of the total distributable income of the fund.

X has not taken ‘reasonable steps’ (see IFM04170) to prevent Y from acquiring 10% or more of the net asset value of the fund. A tax charge therefore arises on X, and this is calculated as follows:

I (net income of the tax-exempt business of the PAIF) = £7,000;

P% (the percentage of the rights to the net asset value of the PAIF held by (or on behalf of) the holder of excessive rights) = 12%.

The amount charged to tax charge is therefore = I x P%, or £7,000 x 12% = £840.