The aim of the offshore funds rules is to make sure that income earned by the fund is taxed as income, ideally in the year the income is earned. If it wasn’t for these rules the investor would not pay tax on income retained or reinvested by the fund but would instead pay capital gains tax on the eventual sale of the fund. The taxation of overseas funds rules thus, try to bring the treatment of overseas funds as far as possible into line with the taxation of UK funds.
Taxation of most UK funds
As a reminder, the tax rules for UK funds, such as OEICs and Mutual funds (see the definitions at the end of the note) aim to put the investor in the same position as if they had invested in the fund’s assets directly (rather than investing in the fund). The rules basically state that income earned by the fund is subject to tax even if it is not distributed to the investor. Thus the tax treatment of the investor is the same, regardless of whether the income is accumulated, re-invested into the fund or paid to the investor.
When the fund is disposed of any income that has been taxed is treated as an expense and thus reduces the profit on the disposal. The profit (or loss) on disposal is treated as a capital gain or loss and the normal Capital Gains Tax rules apply.
Taxation of Offshore funds
The definition of an Offshore is reasonably complex and is contained in the Taxation (International and Other Provisions) Act 2010 s 355. In summary a fund will be an Offshore Fund if:
- it is managed & controlled overseas;
- the investor doesn’t have control over the fund
- the fund invests in a variety of investments; and
- the fund is backed by marketable assets or investments.
The taxation of overseas funds is reasonably complex and depends on whether the fund is a ‘reporting’ or a ‘non-reporting’ fund. You can see a list of approved offshore reporting funds by clicking here.
Tax Treatment of a Reporting Fund
As I mentioned, a reporting fund is a fund that fulfils certain requirements and applies to HMRC for authorisation. Investor’s should get an annual statement from the Reporting Fund that shows the taxable income and gains. As well as showing the amounts actually distributed to investors the statement includes details of the income that the fund earns. This is called the excess income. The excess income and the distributed income together make up the reportable income, which is the amount the investor includes in his tax return. The reportable income is taxed as interest or dividends, as is appropriate.
When the fund is disposed of any reportable income is treated as an expense and thus reduces the profit on the disposal. The profit (or loss) is then treated as a capital gain or loss.
Tax Treatment of Non-reporting funds
Non-reporting funds are split into two groups – transparent and opaque funds. Transparent funds are where investors are regarded as having a share of the underlying fund assets. Opaque funds (also known as non-transparent funds) are where investors are regarded as owning units in the fund rather than as owning precise fractions of the underlying assets.
Tax Treatment of a Transparent Non-Reporting Fund
The Tax treatment of a transparent non-reporting fund is the same as for a Reporting Fund
Tax Treatment of an Opaque Non Reporting Fund
UK investors holding non-reporting funds are only charged income tax on the distributions that the fund actually makes to them. However, the income is taxed as miscellaneous income and not as dividend, interest or savings income. This means that the investor won’t benefit from the dividend or savings allowance and will be taxed at the standard Income Tax rates, which are higher than the dividend rates.
When a unit in a non-reporting fund is disposed of any profit on the sale is taxed as miscellaneous income, not as a gain. The implication of this are that capital gains tax reliefs and rates won’t apply. Also, if the investor makes a loss on the disposal it is treated as nil (not negative) and so loss relief is not available.
- Open Ended Investment Company (OEIC): An open-ended investment company is a type of investment fund domiciled in the UK that invests in stocks, bonds and other securities. The OEIC’s shares are listed on the London Stock Exchange and the price of the shares are based largely on the underlying assets of the fund. OEICs are called « open-ended » because they can create new shares to meet investor demand and cancel the shares of investors who exit the fund.
- Unit Trust: A unit trust is a collective investment vehicle established as a trust rather than a company and is regulated by the Financial Conduct Authority (« FCA »). Unit trusts are characterised as « open-ended » because the trustee can create additional units on demand.
Overview The aim of the offshore funds rules is to make sure that income earned by the fund is taxed as income, ideally in the year the income is earned. If it wasn’t for these rules the investor would not pay tax on income retained or reinvested by the fund but would instead pay capital […]