Sovereign immunity – the principle that foreign governments and heads of state have immunity from certain taxes including Income Tax, Corporation Tax and Capital Gains Tax – is a somewhat esoteric feature of the UK tax system. While the expression “sovereign immunity” might conjour images of bejewelled monarchs, in reality the main beneficiaries of immunity are state investment organisations such as sovereign wealth funds (SWFs) or state pension funds, which invest government resources for the benefit of their populations. UK investments – particularly real estate – have historically been popular with SWFs, which collectively have tens of billions of pounds invested in UK assets. Yesterday’s surprise announcement that the government is consulting on reforms to sovereign immunity is not therefore a niche interest – it will potentially have significant implications for investors, investment managers and the UK’s attractiveness as an investee jurisdiction.

What is the government proposing?

There are several elements to the proposals outlined in the consultation document.

• Firstly, the government proposes to enact legislation comprehensively setting out the eligibility conditions for sovereign immunity, and the effect of being immune. Currently sovereign immunity in the UK is a principle derived from relatively sparse case law, and the government indicates that putting immunity on a statutory footing will provide investors with greater certainty and make the tax system more transparent.
• Secondly, the government proposes removing some of the current benefits that may be obtained by immune entities. Essentially, immunity will be limited to passive investment income and gains, such as dividends and interest. Trading income and, perhaps most importantly, income and gains from UK real estate would be taxable. The government has hinted that it is likely that SWFs would continue to be qualifying investors for the purposes of existing investment regimes such as the substantial shareholding exemption (SSE), the Real Estate Investment Trust (REIT) regime and the Qualifying Asset Holding Company (QAHC) regime, although it intends to examine the practical issues that might raise.
• Thirdly, the government proposes codifying the administrative and reporting rules for sovereign immune entities. The approaches suggested are broadly consistent with how taxes are administered for other investors.

The consultation is scheduled to run until 12 September. The document states that any new rules will come into effect from 1 April 2024, which should provide time for meaningful technical consultation on draft legislation.

What does this mean for SWFs?

SWFs should pay close attention to these proposals and how they develop through the consultation process. While it appears investments in company shares and fixed income securities will not be adversely affected, the tax profile of SWF real estate investments could change significantly. Restrictions to immunity may mean that SWFs need to think more carefully about how they structure their holding vehicles for UK investments – the QAHC regime in particular may become even more attractive. Whether deductions for capital allowances and interest payments are available may also become more significant for SWFs with UK property.