proposed changes will bring in new regulations for offshore funds
The regime for offshore funds will be brought into line with that of onshore funds in the 2004 Finance Bill, the Government has promised.
The proposed changes, announced by the Chancellor in his pre-budget address, will see the current offshore funds regime replaced with new rules that will provide similar tax treatment of investment in offshore funds and equivalent UK products.
The offshore tax regime was put in place to distinguish between funds used to roll up income and convert it into a capital gains tax liability, and those that distribute income on which income tax is paid.
In his pre-budget report, Chancellor Gordon Brown said the current regime is outdated, as the income tax and capital gains tax regimes have been largely harmonised. The proposed changes will be consulted on by Inland Revenue in the run-up to the Bill being brought forward.
The Chancellor's confirmation that changes will be made to the offshore funds regime, which has forced groups such as Scottish Value Management, Franklin Templeton and Close Finsbury, to move offshore funds onshore or launch mirror versions, follows the publication of a consultation document on possible reform of the offshore funds tax regime on 22 April this year.
The rules, put in place almost 20 years ago, were designed to counter the use of particular types of fund to convert income flows into capital gains. Before their introduction, a UK resident investor could accumulate income in a particular type of offshore fund and, when the investment was realised, be subject only to capital gains tax, rather than paying income tax on the accumulated or rolled-up income.
The offshore funds regime introduced the concept of qualifying and non-qualifying funds. Corporate taxpayers apart, investors in a qualifying fund are subject to income tax on income arising from the fund, and to capital gains tax on any gain they realise when they dispose of their interests in the fund.
This matches the treatment of investments in an equivalent UK fund. However, investors in non-qualifying funds are subject to income tax when they make a disposal, the so-called offshore income gain rule. No distinction is made between the income and capital accumulated in the fund.
To secure approval as a qualifying fund, and capital gains treatment for UK resident investors on the disposal of their investments, the fund must be given distributor status by the Inland Revenue, meeting criteria that include distributing at least 85%. Where a fund is constituted as an umbrella fund, the fund as a whole and each class of interest in it must satisfy the required conditions before the fund can be approved as qualifying.
Complaints about the existing offshore funds tax regime were that it has not kept pace with commercial, regulatory and tax changes since their introduction in 1984, that it puts unnecessary obstacles in the way of fund managers wanting to sell their funds to UK investors, and that the rules are discriminatory under European (EC) law.
Key points from respondents:
Many called for the alignment of the regimes for UK and offshore funds and the removal of the tax charge on rolled-up income in UK funds.
Some respondents argued the offshore funds regime could be removed without the need for substantive arrangements.
Some argued that income from investments in particular types of UK fund should be allowed to roll up without an annual income tax charge, in the same way as offshore funds.
The tax advantages identified in 1984 are now much narrower due to alignment of income tax and capital gains tax rates.
Some advocated a full review of the taxation of all savings products.
Targeted anti-tax avoidance measures may be necessary.
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