In its consultation paper of 22 April, the regulator outlined its intention to examine ways of eliminating the separate tax regimes for onshore and offshore vehicles introduced in 1984
onshore and offshore tax treatments is among the proposals the Inland Revenue intends to investigate, as detailed in its consultation paper of 22 April.
If the distinction between the taxation of onshore and offshore vehicles is eliminated, providers and intermediaries stand to benefit from a less complicated system and lower costs.
A separate regime for offshore and onshore tax treatment has existed in the UK since 1984 and has changed very little since then.
The Revenue is planning to consult with fund managers and other relevant parties on how the current regime for taxing offshore funds might be improved. It proposes investigating the current system to find out whether it should be retained, reformed, abolished or replaced.
The main difference between the tax treatment of onshore and offshore vehicles is liability to capital gains tax, which is subject to taper relief, applicable to all onshore funds and the offshore distributor funds.
Head of retail sales and marketing at Dresdner, Nick Smith, says for onshore products such as unit trusts, income is taxed at income tax rates and so a higher-rate taxpayer will often prefer a capital gains liability, which can be offset using taper relief, to high levels of income tax.
'For offshore products, there are two types of fund: the distributor fund and the accumulating fund. The distributor fund aims to distribute 80% of its income and has to apply for distributor status. This type of fund receives the same tax treatment as an onshore vehicle,' he adds.
If a fund does not have distributor status to be marketed in the UK, it is treated as an accumulating fund, where all gains are treated as a marginal rate and subject to income tax ' including those that would normally be considered capital gains.
Taper relief does not apply to this type of product. Because of this, accumulating funds are not generally marketed to UK investors.
Gordon Richardson, technical manager at Hargreaves Lansdown, says: 'The current regulation is that tax is not payable on an accumulating fund until the investor sells the fund, after which income tax is paid on the accumulated income.'
Smith argues that there are some rare advantages for holding accumulating funds, however. 'With accumulating funds, an investor can choose the point at which they are taxed,' he says. 'For example, a higher-rate taxpayer may choose to keep the fund until retirement, at which point he qualifies as a lower-rate taxpayer.'
The proposed changes, which may see the introduction of accumulating and distributing share classes on a fund, will be material to providers and intermediaries, adds Smith.
'Product providers cannot have distributor funds and accumulating funds within the same umbrella as this would not classify for distributor status,' he notes. 'Therefore, many providers have two ranges of funds, which leads to a lot of duplication in administration and services provided.
'If changes are made, providers will be able to consolidate their fund ranges, which would be a more efficient solution. It would eliminate the unnecessary cost of running separate umbrellas and providers would be able to run distributor and accumulator sub-funds within the same umbrella.'
Smith suggests intermediaries will benefit from this, as it creates simplicity and will slim down the number of offshore umbrellas. The complexity of offshore taxation has often deterred intermediaries from using off- shore funds.
Moreover, the total cost of funds should come down because, as range mergers take place, fixed costs become smaller and the total expense ratio of the fund diminishes.
The Government's objectives in this tax review are that:
• UK investors are taxed fairly on their savings and investments.
• Appropriate account is taken of market and business factors and, in particular, the significant commercial developments since 1984 when the current offshore funds regime was introduced.
• The UK remains an attractive place for funds business.
• UK-based funds (as well as those based offshore) are not made uncompetitive.
• Proper account is taken of other developments in UK tax legislation.
• As far as possible, any changes in tax law that are made as a result of the review are simple to understand and operate and that UK investors and fund managers are not faced with costly compliance pressures.
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