M&G fund’s conversion may foster faith in the PAIF regime

Other PUTs expected to follow M&G fund’s switch to tax-transparent vehicle, writes Jane Roberts

Property authorised investment funds look set to finally become established vehicles for open-ended funds next year. This month, investors in M&G Investments’ flagship £2bn property fund voted to convert from an authorised property unit trust to an open- ended investment company with PAIF status.

More of the nine other APUTs are expected to follow suit next year with Threadneedle’s PUT thought to be next. Aviva is another and Philip Nell, fund manager of Aviva Investors Property Trust, says: “We are working on a potential conversion of the AIPT in 2013.”

The attraction is the tax efficiency of the PAIF regime. As an APUT, M&G Property Portfolio paid 20% tax on rental income, but from January, non-tax-paying investors, such as pension funds and eligible investors including ISA investors, will receive rental income with a reclaimable tax credit, or will be paid gross. This puts the fund’s tax efficiency on a par with a REIT.

The PAIF regime was introduced in April 2008 but was slow to take off; just a handful of funds have launched or converted (see table). M&G is the pioneer among the big existing property funds open to retail investors. AREF chief executive John Cartwright says: “There was understandably little take-up at first as the impact of the credit crisis was the main concern then.”

More recently, conversion costs have been a hurdle. Because not all income potentially paid by a PAIF carries the reclaimable tax credit, PAIFs have to be set up to ‘stream’ income and the fund ‘platforms’ that distribute products and manage funds  have to be able to accommodate streaming. However, investors still receive one payment.

Andrew Watson, M&G director of advisory and partnership sales, says M&G shouldered this cost and is in talks with around 20-25 partner platforms it works with about them developing their systems. The platforms’ own priority in recent months has been adapting their systems for the Retail Distribution Review, which comes into effect in January.

A boost to investors’ income

Watson says while PAIF status is essentially “a tax wrapper that won’t change the strategy of the M&G Property Portfolio in any way, receiving income more efficiently is a huge boost…. The platforms, while very busy preparing for the RDR, understand the benefits of PAIFs and are keen to get the kit built. They also have an incentive: as more  funds convert, we imagine investors will  send them signals to get more tax efficient.”

Melville Rodrigues, a partner at CMS Cameron Mckenna who is a fund specialist, agrees. “Given M&G’s pioneering approach, we could experience a domino effect, with other retail property unit trusts converting to PAIFs,” he says, “This could be a tipping point for the platforms, too: with RDR and other changes, such as the FSA encouraging retail investors towards authorised schemes by restricting promotion of unregulated collective investment schemes, they will recognise the value of adapting their systems to triple streaming.”

Christopher Down, chief executive of Hearthstone Investments, says that depending on a fund’s income yield, the advantage to tax-exempt investors “can be quite high, perhaps 70-90 basis points”.

With a business case made, M&G’s fund will convert in time for the ‘ISA season’ before the end of the April 2013 tax year. While retail investors consider many things when selecting funds, not least track record, “M&G will be getting out there to see if it can attract those funds and the tax exemption is good marketing”, according to one source.

Cartwright says AREF’s next step is to see if it can persuade the government to give other property funds the same Stamp Duty Land Tax exemption as HMRC granted to APUTs that convert. “If an insurance-linked fund wants to put assets into a PAIF it gets caught,” he says. “Defined benefit pension schemes, which have to close eventually, could transfer assets to a PAIF if SDLT wasn’t an issue. But things have been made difficult for property fund managers because the previous SDLT relief was comprehensively abused by other parts of the industry.”