Collective Investment Schemes - To be or not to be?

Amendments to collective investment scheme "joint venture" exemption - particularly relevant to property transactions involving use of SPVs

The long-awaited amendments to paragraph 9 of the Financial Services and Markets Act 2000 (Collective Investment Schemes) Order 2001 ("CIS Order")  have now been made and will become effective from 15 July 2008. The aim is to allow those setting up joint venture and co-investment arrangements greater freedom to use special purpose vehicles as a party to the arrangement. This should be of particular relevance to property transactions which often involve the use of special purpose vehicles ("SPVs") as investors.

The CIS Order lists instances in which arrangements which would otherwise be considered collective investment schemes under Section 235 of FSMA are exempt and can therefore be established without an FSA authorised operator. Before the amendment, paragraph 9 of the CIS Order exempted arrangements where each of the participants entered into the arrangements for commercial purposes in the pursuit of an existing business. There was uncertainty where, for example, a property developer and a commercial business entered into a joint venture to develop a property and one party (or both) wanted to hold their interest in the venture in a newly incorporated SPV with no existing business.

The substituted paragraph 9 inserted by the amending statutory instrument replaces the exemption with one for arrangements where all the participants are "permitted participants". The new paragraph 9 also allows participants to opt that the exemption shall not apply so that the arrangements are therefore treated as a collective investment scheme. There are also grandfathering arrangements for arrangements in place before 15 July 2008.

Some of the key points are set out below:

• The definition of "permitted participants" includes not only (as at present) businesses which are carrying on a commercial (and not financial services) business and enter into the arrangement for commercial purposes wholly or mainly related to that existing business, but also an entity (for example, an SPV company, partnership or trust) which, though itself has not previously carried on a business, only has as its members, partners or beneficiaries businesses which would themselves qualify as permitted participants if they participated directly themselves.
  
  The changes also make clear that a financial services entity which also carried on a separate commercial business which does not involve financial services can qualify as a permitted participant if the arrangements relate to the commercial business.
   
  • To take the above example, the commercial business could form a wholly-owned single member subsidiary as the joint venture partner in the development. Care should be taken not to use nominee shareholders who do not qualify as permitted participants or who are financial services businesses.
     
• Arrangements first set up on or after 15 July 2008 in which all participants are permitted participants will be exempt, but the participants can elect unanimously not to benefit from the paragraph 9 exemption so that the arrangements amount to a collective investment scheme. An election by the participants is for the life of the scheme and cannot be revised by a later agreement.
   
  • It will now be important for new offshore unit trusts which benefit from being a collective investment scheme from a tax perspective to agree its collective investment scheme status in writing.
     
• Participants in existing arrangements set up before 15 July 2008 which were not exempt under the old rules, but which would be under the new rules (ie, they are all permitted participants) can elect to benefit from the new exemption from then onwards if they unanimously agree in writing. An election by the participants is for the life of the scheme and cannot be revised by a later agreement.
   
  • Some existing transactions involving SPVs which were treated as collective investment schemes and were therefore required to have an operator authorised by the FSA may qualify for the exemption and, by unanimous election, cease to be such schemes. They would no longer be required to have an FSA authorised operator and the financial promotion restrictions applicable to such schemes would no longer apply. This may be attractive from a cost-saving perspective. In addition, not using a regulated entity will of course remove regulatory risks and regulatory "red tape". However, there may be tax consequences that need to be considered.
     
• Participants in existing arrangements set up before 15 July 2008 which benefited from the old paragraph 9 exemption will continue to be exempt so long as they comply with the new paragraph 9 requirements ie, all their participants are permitted participants.
   
  • The definition of a "permitted participant" requires the person concerned to enter into the arrangements for commercial purposes "wholly or mainly related" to the existing business. The old exemption only required the commercial purpose to be related to the business. There is some uncertainty as to how far this change is retrospective.
     
• Whether a person is a permitted participant generally is determined when they join the arrangement but, in the case of an SPV, the requirements appear to be continuing.
   
• However, if a person becomes a participant in exempt arrangements without being a permitted participant at the time, the arrangements cease to be exempt and become a collective investment scheme for so long as that person remains a participant.
   
  • In some cases it may be appropriate to include provisions in exempt arrangements for ensuring they continue to qualify for the exemption, for example, having qualification requirements for any replacement as a participator.

The Treasury started to consult on amendments to the CIS Order at the beginning of last year. This was followed by further consultation in August 2007. Finally, The Financial Services and Markets Act 2000 (Collective Investment Schemes) (Amendment) Order 2008 was laid before Parliament at the end of June this year. It has been necessary for an amending statutory instrument to be passed since then to correct some typos and to make other drafting changes.

If you have any questions, please contact Patrick Buckingham or Scott Cochrane.

The content of this article does not constitute legal advice and should not be relied on as such. Specific advice should be sought about your specific circumstances.

Herbert Smith LLP, Gleiss Lutz and Stibbe are three independent firms which have a formal alliance.

© Herbert Smith LLP 2008