Funds with foreign sovereign investors under threat from proposed UK tax reform

HM Treasury has set out a revised approach to the UK's sovereign immunity from direct tax in its recent consultation, which ran from 4 July to 12 September 2022, that could have major financial implications for funds whose investors include foreign sovereign investors.

Osborne Clarke, in a response to the consultation, has highlighted the need for any legislative changes, particularly to the "qualifying institutional investor" status, to be effected in a way that does not incur significant additional expense for fund managers.

Existing exemptions

Under current tax policy, foreign sovereign investors – natural persons and extensions of the state, including entities such as funds or "bodies corporate" – are exempt from liability to direct tax in the UK.

The UK's exemption applies to all activities of sovereign persons, including both those that are generally associated with their sovereign functions and that are more commercial in nature; in this regard, it differs from other countries with arrangements in place that provide tax exemptions only for some foreign government investments. The UK's sovereign immunity exemption is also not yet codified into UK law.

The government considers that there is a case to bring the regime into legislation and to restrict the exemption so that it applies only to income arising from certain investment activity (principally, debt and equities). This means that, in practice, sovereign persons' income and gains from UK immovable property as well as their income from UK trading activities would be brought within the scope of tax.  

Consultation response

As well as the need to avoid extra financial burdens on fund managers, we also suggested in our consultation response that there should be a lead-in time to allow for existing investors to exit, should that be their wish, and for fund managers to ensure that appropriate steps can be take (where necessary) to safeguard the continuing tax exemption for fund entities where sovereign investors no longer constitute qualifying institutional investors.

We also responded to some specific questions raised by the government on foreign government pensions schemes, transitional arrangements and rebasing. 

Osborne Clarke comment

We acknowledge the government's proposals to enshrine the exemption into legislation and to ensure a level playing field not just between the UK and other jurisdictions but between different categories of investors into the UK; notably, investments in UK real estate.

However, there are aspects of the proposals that need careful consideration to ensure the UK remains a competitive jurisdiction for inward investment by sovereign wealth funds and foreign public pension funds. 

If you would like to discuss the consultation and our response in more detail, please speak to one of the contacts below.