The changes to the pension investment sector are taking shape, but key tax policy questions remain unanswered.
The Government’s ambitious post-election pensions investment review is progressing with impressive speed. The call for evidence conducted during September received over 200 responses, a cross-departmental directional interim report was published earlier this month, and consultations on both the workplace defined contribution (‘Unlocking the UK pensions market for growth’) and the Local Government Pension Scheme (‘Fit for the future’) aspects of the reforms are underway and run until 16 January 2025. The process is expected to culminate, after a second phase of the review, with the publication of a Pensions Scheme Bill in the spring.
Without detracting from their (considerable) scope and intricacy, the proposed reforms might be summarised by a single headline-grabbing term used by the Chancellor in her recent Mansion House speech: ‘megafunds’. The policy, as confirmed in the interim report, is to ‘take advantage of scale and consolidation to deliver greater investment in UK productive assets and better returns for UK savers’. The expectation is that increased size will – through economies of scale and market power – enable more diversified investment into growth-enhancing asset classes including infrastructure and private equity, where Australian and Canadian pension schemes currently invest ten times more than comparable UK schemes.
To this end, consolidation of DC schemes is envisaged through the imposition of minimum size and maximum number requirements on default funds by 2030. The functions and scale of the eight asset pools established by the 92 LGPS authorities will likewise expand significantly, through a range of measures including legacy asset transfers, on an even more ambitious indicative timeline of March 2026. The Government’s estimates suggest that assets under management in the consolidated funds could reach £1.3 trillion in aggregate by 2030 and that the reforms could ‘unlock around £80bn for investment in private equity, including exciting growth businesses, and in vital infrastructure projects including transport, energy and housing projects here in the UK’.
A key aim of the measures is therefore to maximise investment by the new megafunds in productive assets, especially in the UK (but without geographic limitation). Tax is an obvious policy lever with potential to support this, but there is no indication – yet – in the engagements with stakeholders as to whether or how it might be used. Various respondents to the Call for Evidence have nonetheless highlighted areas where changes to the tax treatment of pension investment returns would promote investment. The reincarnation of the tax credit for UK pension funds receiving dividend income net of Advance Corporation Tax (as was), abolished in Gordon Brown’s first Budget, might look unlikely given the rationale for that change was removing a perceived distortion away from reinvestment. But the Government could look creatively at other methods of reducing the strain placed on the middle stage of the putative EET (Exempt-Exempt-Taxed) pension tax model by the intervening layer of corporation tax impacting pension investment models calculated on a net return basis. Other respondents have called for exemptions from stamp duty and SDRT and other targeted changes.
More generally, the current working assumption is that the megafunds will enter or remain in the FA 2004 regime for registered pension schemes. As a result, they would generally enjoy exemption from income tax and CGT on returns on investments held for the purposes of the scheme (but be taxable on other returns), meaning the investment/trading distinction will remain of critical importance. Determining the character of returns from private capital investment structures is frequently far from straightforward, as advisers familiar with structuring and negotiating fund investments will recognise, and there may be a case for revised and expanded HMRC guidance or even the introduction of a novel clearance mechanism in this area. A holistic review of the approach taken to potentially-taxable asset classes including certain residential property sector and plant and machinery investments would also be beneficial. For non-UK investments, a review of how well the UK’s treaty network supports pension funds (through eliminating source-state withholding and other non-resident taxes) would be welcomed, as would any enhanced guidance on foreign entity classification.
In summary, tax needs to enter the megafund conversation.
Home >Articles > Pension ‘megafund’ reforms: how does tax fit in?
Pension ‘megafund’ reforms: how does tax fit in?
The changes to the pension investment sector are taking shape, but key tax policy questions remain unanswered.
The Government’s ambitious post-election pensions investment review is progressing with impressive speed. The call for evidence conducted during September received over 200 responses, a cross-departmental directional interim report was published earlier this month, and consultations on both the workplace defined contribution (‘Unlocking the UK pensions market for growth’) and the Local Government Pension Scheme (‘Fit for the future’) aspects of the reforms are underway and run until 16 January 2025. The process is expected to culminate, after a second phase of the review, with the publication of a Pensions Scheme Bill in the spring.
Without detracting from their (considerable) scope and intricacy, the proposed reforms might be summarised by a single headline-grabbing term used by the Chancellor in her recent Mansion House speech: ‘megafunds’. The policy, as confirmed in the interim report, is to ‘take advantage of scale and consolidation to deliver greater investment in UK productive assets and better returns for UK savers’. The expectation is that increased size will – through economies of scale and market power – enable more diversified investment into growth-enhancing asset classes including infrastructure and private equity, where Australian and Canadian pension schemes currently invest ten times more than comparable UK schemes.
To this end, consolidation of DC schemes is envisaged through the imposition of minimum size and maximum number requirements on default funds by 2030. The functions and scale of the eight asset pools established by the 92 LGPS authorities will likewise expand significantly, through a range of measures including legacy asset transfers, on an even more ambitious indicative timeline of March 2026. The Government’s estimates suggest that assets under management in the consolidated funds could reach £1.3 trillion in aggregate by 2030 and that the reforms could ‘unlock around £80bn for investment in private equity, including exciting growth businesses, and in vital infrastructure projects including transport, energy and housing projects here in the UK’.
A key aim of the measures is therefore to maximise investment by the new megafunds in productive assets, especially in the UK (but without geographic limitation). Tax is an obvious policy lever with potential to support this, but there is no indication – yet – in the engagements with stakeholders as to whether or how it might be used. Various respondents to the Call for Evidence have nonetheless highlighted areas where changes to the tax treatment of pension investment returns would promote investment. The reincarnation of the tax credit for UK pension funds receiving dividend income net of Advance Corporation Tax (as was), abolished in Gordon Brown’s first Budget, might look unlikely given the rationale for that change was removing a perceived distortion away from reinvestment. But the Government could look creatively at other methods of reducing the strain placed on the middle stage of the putative EET (Exempt-Exempt-Taxed) pension tax model by the intervening layer of corporation tax impacting pension investment models calculated on a net return basis. Other respondents have called for exemptions from stamp duty and SDRT and other targeted changes.
More generally, the current working assumption is that the megafunds will enter or remain in the FA 2004 regime for registered pension schemes. As a result, they would generally enjoy exemption from income tax and CGT on returns on investments held for the purposes of the scheme (but be taxable on other returns), meaning the investment/trading distinction will remain of critical importance. Determining the character of returns from private capital investment structures is frequently far from straightforward, as advisers familiar with structuring and negotiating fund investments will recognise, and there may be a case for revised and expanded HMRC guidance or even the introduction of a novel clearance mechanism in this area. A holistic review of the approach taken to potentially-taxable asset classes including certain residential property sector and plant and machinery investments would also be beneficial. For non-UK investments, a review of how well the UK’s treaty network supports pension funds (through eliminating source-state withholding and other non-resident taxes) would be welcomed, as would any enhanced guidance on foreign entity classification.
In summary, tax needs to enter the megafund conversation.
