Funds will be required to sell shares to ensure their assets are less than 50 per cent invested in these non-recognised exchanges. Failure to do so will threaten their eligibility for capital gains tax relief. Individuals who opted for self- invested emerging market PEPs will also lose their tax breaks.
The Revenue has told Pepma, the 101-strong PEP managers' association, that it intends to collect CGT on gains made in the 1993/4 tax year on PEPs that breached the rules. In its letter to the association, the Revenue says it will be writing to all PEP plan managers and "no-one involved will escape unscathed".
In a separate move earlier this month, the Revenue reached a private deal with the Association of Unit Trusts and Investment Funds and the Association of Investment Trusts Companies (Autif) over their members' liability to CGT. Three AITC members are believed to have agreed to pay CGT worth more than £530,000 for 1993/4. A further seven Autif members paid £50,000 between them.
Philip Warland, director-general of Autif, stressed that tax payments would be made by PEP managers, not individual investors. He said: "The PEP allowance of individual investors was unaffected even though people were invested in funds that were technically not PEPpable."
The Revenue has now asked Pepma to help it to track down PEP managers who have breached the rules. Those most likely to be affected are private- client stockbrokers with self-select or advisory PEPs. Some could face CGT bills for thousands of pounds.
The tax liability arose because of confusion caused by a Revenue rule change in April 1993. This required PEP managers to divest from "non-qualifying" investments, including gilts and non-recognised stock exchanges.
Some managers assumed the approved list of securities markets was issued by their regulatory body, the Securities and Investments Board. It later emerged that the Revenue had its own list of recognised stock exchanges, which excluded four markets on the SIB list.
The four markets - Mexico, Malaysia, South Korea and Thailand - have attracted a significant proportion of the money that flowed into emerging market funds during the peak of the boom in those areas in 1992-93. Last October the Revenue finally recognised these four markets, but is sticking to its plans to claw back CGT arising from investments in them during 1993/4.