Key legal updates for funds and real assets - 2015/16 in summary

This article was produced by Nabarro LLP, which joined CMS on 1 May 2017.

Summary and implications

Last week we updated a room packed with real assets fund managers, investors and landlords on some of the last 12 months' tax, regulatory and legal developments. Here is a summary and a link to the slides, for those who couldn’t make it.

Bite-size fund taxation: carried interest, BEPS and CoACS

• It’s been a difficult 18 months for the tax treatment of carried interest. New rules reduced its scope, and the effective rate of tax rose to 28% whilst the general top rate of capital gains tax fell to 20%. The latest issue is a minimum required holding period of four years. This creates a potential misalignment between managers and investors as the same holding period does not apply to the fund itself. Managers will want to hold on to assets for at least four years, whilst investors’ interests are best served by letting the market dictate the timing of disposals. Even so, this favourable regime for managers of private equity style funds is certainly still available.
• BEPS is coming. April 2017 will see restrictions on excessive interest deductions. The UK will go from having the most benign tax regime for interest deductions in Europe to one of the most stringent. In addition certain funds could soon be prevented from claiming treaty benefits, and offshore trading structures for UK property development have been killed off by new rules on the artificial avoidance of a permanent establishment. The latter is unsurprising, as BEPS’ main purpose is to tie tax liabilities more closely to where value is created.
• Introducing… the UK Offshore Unit Trust! The CoACS is income transparent, exempt from capital gains and now free of SDLT on transfers – like a unit trusts set up in the Channel Islands. From a tax perspective therefore, the CoACS is now a viable property investment vehicle. But it is also an FCA regulated fund vehicle so won’t be suitable as an SPV holding structure.

Bite-size regulation: CoACS, AIFMD, MiFID II, SMR …and property crowd-funding

• The most attractive regulatory option for the CoACS is the qualified investor scheme (QIS). The QIS allows a broader choice of investment strategy than other UK authorised funds, whose wider retail capabilities are in any case likely to be nullified in practice by the CoACS' £1m minimum investment requirement. A QIS does need an AIFM with permission to manage authorised funds, but overall the existing regulatory regime is unlikely to discourage the use of this “onshore Jersey unit trust”.
• AIFMD II (due in 2017) shouldn’t introduce wholesale changes, but valuer liability rules will hopefully be addressed, marketing rules need tightening to end the patchwork of gold-plating by different members states, and it would be good to see some third country passports actually granted (click here to see the current position).
• MiFID II, conversely, is a huge task for investment firms, but with a fairly limited (but not insignificant) impact on real asset fund managers and investments. Click here for more information on our MiFID II Project Manager tool which is free to try.
• The senior managers regime will replace the approved persons regime for authorised firms from January 2018. Map out who is responsible for which regulated functions, and make sure senior managers know they are individually accountable for regulatory failings in their area. No more Nuremburg defence.
• Finally, a “shameless plug” for property crowdfunding. Nabarro acts for almost 40 platforms in the debt and equity real estate crowdfunding market, which had already hit £700m by 2015. “Real estate is taking off” (according to Nesta and Cambridge University). We’ve seen property crowdfunding rapidly expanding across sectors, from residential to commercial, and institutional money is now skating round the edges. Watch this space.

Property as a business – non-property legal considerations

• Don’t forget employment law! Firstly, the TUPE Regulations mean that appointing a property manager can leave you, on termination of the relationship, with responsibility for employees that neither you nor they realised were going to become your employees. So negotiate provisions for allocating cost and risk, and perhaps indemnities, to make finding a new managing agent easier. With direct property transactions you should also plan for the possibility of automatic transfers of employees between buyer and seller, from security guards to head office staff. Secondly, consider the Modern Slavery Act 2015. If your turnover is over £36m you must make an annual statement, not only that you aren’t underpaying or otherwise enslaving anyone, but also that your suppliers aren’t. This includes where a fund appoints a property manager, who then employs cleaners, security guards, receptionists – all categories considered vulnerable to abusive practices.

• Don’t forget data protection rules! Data protection broadly covers “personal data”, which is information from which you can identify an individual. CCTV footage, building access information and wi-fi login data from mobiles can all fall into this category. Certain real estate sectors like student accommodation are particularly affected. When you’re collecting personal data you must notify the UK’s Information Commissioner and implement robust internal policies. Actions that risk breaches include landlords' sharing of information with tenants and vice versa. Finally, watch out for transfers of data to the US, where the rules aren’t as tight and contractual protections may be needed to prevent personal data being shipped to the US by affiliates, clients or suppliers.

• Don’t forget cybercrime! Large fines (e.g. Talk Talk) and potentially fatal reputational damage (e.g. Ashley Madison) are the risks here. This is usually not about businesses having actively done something wrong, more often about them not having taken enough precautions nor reacted to warnings. There is a host of safeguards you can put in place, from policies to PR plans.

Brexit and real estate investment

There has been a lot of market volatility and even greater political turmoil since the referendum, which began the busiest few months of many Nabarro lawyers’ careers. Are we on? Are we off? Transactions have been spluttering, pausing, then restarting …. what impact have we seen on legal documents?

• Brexit clauses which allowed buyers to walk away in the event of a Leave victory were included in one or two significant purchase contracts before the vote. There were concerns immediately afterwards around debt and Brexit's impact on the City office market in particular. The recent announcements of major London transactions for Wells Fargo, Apple, Google and Bloomberg, plus AXA’s decision to press on with developing 22 Bishopsgate all show rents and City office demand are holding up, and the Brexit process has a timeline, so future Brexit termination drafting is less likely.
• Fund documents have in some cases been drafted to allow managers and funds to change domicile to allow continued smooth operation post-Brexit (particularly around costs), and it is now common to include risk warnings about the possible negative impact of Brexit in marketing documents.
• Finance documents often contain material adverse change (MAC) clauses. Real estate finance documents tend to define MAC as something that the majority of lenders agree has a material adverse effect on the business, operations, property, condition or prospects of a borrower. Could Brexit be used as a trigger and should this be anticipated in drafting going forward?
• Investment policies and boiler-plate definitions of the EU, the EEA and even the UK are being revisited to ensure original business plans can be followed.

For a copy of the slides for this event, please click here.

For more information, please use the practice area links below.