New rules help British offshore investors

The transition period after which distributor status for offshore funds will be phased out and replaced by reporting fund status is coming to an end.

Since December 2009, non-British domiciled funds have been able to apply for reporting status. One of the main benefits is that it allows British resident investors in such funds to obtain favourable capital gains tax (CGT) treatment instead of gains being subject to income tax. This has long been a concern for investors wanting to buy offshore funds that do not have distributor status.

The aim of the change is to provide for a less onerous certification process and greater certainty for funds and their investors. Following a fund’s first accounting period – which ends after December 1, 2009 – for the succeeding accounting period the fund can either enter into reporting fund status or apply for distributor status for a further year.

Under the new regime, instead of having to distribute income, funds will report 100% of the income attributable to their investors, with a 10% margin for error. There will no longer be a need physically to distribute income; rather, there may be deemed distributions or a combination of physical and deemed distributions. British investors in a reporting fund will be taxable on their share of income in the fund whether or not it is distributed. (article continues below)

The 5% limit on investments in non-qualifying offshore funds that applies to distributing funds has been abolished for reporting funds. This should make it easier for funds of funds to gain certification as reporting funds. Where a reporting fund invests in other reporting funds, it will receive information from those funds to enable it to calculate its own reportable income.

Toby Hogbin, the head of product development at Martin Currie, says a key attraction of reporting fund status is that it is applied for only once, whereas distributor status had to be applied for yearly. “This gives tax certainty from inception.” Hogbin says it is also better for investors. “Clearly, for a taxpayer at the highest rate it’s very significant. There’s a 22 percentage point difference in the tax rate.”

Commerzbank Corporates & Markets (C&M) has applied for reporting status on all its funds. Huw Price, its head of investment management structuring, says the regime is fundamentally about qualifying a fund for CGT treatment on capital gains rather than the default of all returns being taxed as income. While there is a favourable difference in the rates and allowances for CGT against the marginal rates of income tax, being in the regime is a must for any provider offering funds not domiciled in Britain.

Price says reporting status has two main advantages. “Firstly, that of certainty: since reporting status is elective, clients and their advisers know the tax consequences of investment in an offshore fund with reporting status before they invest, as opposed to the retrospective nature of distribution status, where the provider applied to HMRC on production of its annual report and accounts. There was always a feeling of being under the sword of Damocles until HMRC confirmed distributor status.”

Second, he says, distributor status did not efficiently allow for accumulation of income, whereas the reporting status allows a provider to report a deemed distribution. “This is important where a fund has income but this is not the rationale of the fund and investors would rather see this reinvested than paid out,” he says.

Given the uncertainty over cross-border tax under Ucits IV, any move to simplify the offshore tax regime is likely to be welcomed by investors.