Tax Talk: When is a switch chargeable?

Tax Talk is a regular series written by FSL’s tax expert, Alex Ranahan. Alex has nearly ten years’ experience as a tax adviser and analyst. He is accredited by The Association of Taxation Technicians and was recently elected co-chair of the Tax Committee for The Investing and Saving Alliance.

Alex’s Tax Talks are on general topics and are not tax or financial advice. If you are unsure of the tax treatment of a transaction, we encourage you to seek the appropriate tax advice. 

Ah, the month of April. Not just for showers but also for the final preparations before reporting season – sorry! In this Tax Talk, I discuss a question we frequently get asked by our clients at FSL.

Let’s dive in. 

Switches

One common query we get from clients is about when a switch is chargeable and when it isn’t. Some examples of switches we have been asked about include: 

• Switches from accumulation units in a unit trust to income units in the same unit trust 
• Switches from US dollar units in a reporting fund to Euro units in the same fund 
• Switches from the hedged class to the unhedged class of the same fund 

The first and most crucial point to bear in mind when considering a transaction is this: if a disposal has taken place, you should consider it a chargeable disposal unless there exists a rule that says it is not a chargeable disposal. 

Often, we hear from clients who assume that something must be non-chargeable or exempt from tax because they heard that something similar was exempt.   

Many in the industry are aware that the first example above, of a switch between accumulation and income units in the same unit trust, is permitted as a non-chargeable switch. Fewer know that the reason for this is a set of rules – much changed over the years – which in their current form are the “Collective Investment Schemes: Exchanges, Mergers, and Schemes for Reconstruction.”

General principles

I could write a whole article on these rules, but the general principles are as follows:

• Reorganisations or reconstructions of the fund that affect all investors, or which are offered to all investors on the same terms, are likely to be non-chargeable unless the original asset is an offshore non-reporting fund, and the new asset is something else.
• An investor choosing to exchange units in one fund for units in another fund may only treat their exchange as tax-free if their investment is worth the same before and after the switch, and they have the same underlying property and rights to it.

Chargeable or non-chargeable?

So, going back to our examples above. The reason the first switch is non-chargeable is because the property is the same. The investor has the same rights to the underlying property, they have just chosen to receive the income from the fund differently.

The second switch is less clear, but the same principles apply. The investor is invested in the same underlying assets because the fund is the same, and their rights to those assets remain. The change is solely in the currency in which they receive their income from those assets. So, based on the principles established, this switch is non-chargeable.

The third type of switch causes issues. The property in this case is not the same before and after the switch, and the investor’s right are different.

In a summary of responses to their consultation on the draft legislation in March 2013, HMRC said:

“The hedge (or similar) may constitute a major part of the asset and we would therefore expect there to be an economic investment decision involved in deciding to switch. Because of this in those circumstances the relief in s103F would not apply.” 

The hedge is itself considered part of the asset so this switch would be chargeable because it does not receive relief and therefore there is no reason for it to be non-chargeable.