Rebate of management fees

The taxation of the rebates referable to BLAGAB paid by the manager of an AIF to a life insurance company has always struck me as unfair. Rebates are typically paid where an insurer invests in a retail share class that has a relatively high level of charges and the rebate is a  discount recognising that the life insurance company is an institutional investor and that a retail level of charge is not appropriate.  

I think it is generally accepted that such rebates are taxable in the life insurers I-E tax computation as FA 2012 section 92 (Formerly FA 89 section 85) applies.  But if the rebate is being made by an AIF investing in equities then the management fee has not obtained tax relief as the AIF will not have (significant) taxable income.  Accordingly, it seems inappropriate that the life company should have to tax the rebate in its I-E computation.

If an AIF offers an institutional share class as well as a retail share class then it would, all other things being equal, be sensible for the life company to invest in the institutional share class.  To illustrate the point say there were two equity AIF share classes identical in every way except that one charged 2% per annum and the other 1% per annum and the high charging fund would pay a rebate of 1% to large investors such as life insurers.

Assuming a 3% yield in the AIFs the low charging fund would pay a non taxable dividend of 2% (yield of 3% less 1% management charge).  The high charging fund would pay a tax free dividend of 1% (3% yield  - 2% management charge) and a 1% rebate that would be taxable - but really shouldn't be.

Another option for life insurers might be the use of the proposed contractual scheme for collective investment (i.e. UK transparent funds http://www.hmrc.gov.uk/drafts/csci.htm).  I think HMRC sees these as being primarily of interest for pension schemes but they might also be of use to life insurers with BLAGAB business currently in AIFs.

Obviously it is not always possible for a life insurance company to invest in an institutional share class or transparent fund  so it would seem appropriate to provide relief for rebates from equity AIFs in the legislation.  However, there might be practical issues around the drafting of any exemption.