The existing offshore funds rules seek to tax certain gains of investors in offshore funds as income. However, provided the offshore fund qualifies as a “distributing fund” during the period of ownership such gains remain subject to tax as capital gains.
In order to so qualify the offshore fund must distribute at least 85 per cent of its annual income and comply with certain investment restrictions. The UK Government now proposes the introduction of a new tax regime to change the rules that determine the type of fund that can confer capital gains treatment on its investors.
This is particularly relevant now that the capital gains tax rate for individuals is 18 per cent and given the planned increase in the highest marginal rate of income tax to 45 per cent (from 2011-12).
In summary, the proposals provide for the following:
• replacement of 'distributing fund' status with 'reporting fund' status whereby instead of having to distribute income, funds will be required to report 100% of the income attributable to their investors. There will no longer be a need to physically distribute income but rather there may be deemed distributions or a combination of physical and deemed distributions. A UK investor in a reporting fund will be taxable on its share of income in the reporting fund whether or not it is actually distributed;
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• the investment restrictions currently applying to distributing funds will be abolished. This will make it easier for funds of funds to achieve certification as reporting funds;
• managers of offshore funds will be able to obtain forward looking certification of a fund as a reporting fund which will continue to apply until the fund chooses to leave or is removed from the regime. This is unlike the current distributing fund regime where certification must be sought annually and retrospectively which can cause uncertainty for investors;
• breaches of the rules will not necessarily cause the fund to lose reporting fund status, and it is only where these are serious breaches or persistent breaches that this will be the case. This is unlike the current distributing fund rules where a simple breach can lead to loss of distributing fund status;
• there will be transitional provisions, to allow existing distributing funds to become reporting funds, and for investors to continue to receive capital gains tax treatment;
• there will be a new principles based definition of ‘offshore fund’ which may lead to some funds which are currently outside the scope of the UK’s offshore funds tax rules being brought within their scope.
David Gubbay is tax partner at Dechert LLP. The views expressed here are his own.