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Comment: Robert Mellor
On 31 March of this year, the UK HM Revenue & Customs (HMRC) saw an onslaught of up-front applications being made by offshore funds for UK reporting fund status. Almost three months on, we have seen many changes to the environment in which these funds operate, most recently, the new UK government’s proposals on capital gains tax (CGT) and the subsequent implications for the investment management community.
As a result of these recent developments, many funds might be wondering if reporting status will provide any benefits for UK individual investors if the CGT rate is changed to become the same as the income tax rate. So, where are we and what does the future look like for these funds?
The UK reporting fund regulations came into effect for accounting periods beginning on or after 1 December 2009. These rules replace the distributor status regime which, for those offshore funds which had certification, granted UK investors capital gains tax treatment (18% for individuals from April 2008) on the gain on disposal of their units, provided that 85% of the fund’s income was distributed to investors each year and taxed in the UK as income (40/50%).
Under the new regime, both distributing and non-distributing funds may now apply for UK reporting fund status (as income is required to be reported rather than distributed) which will allow their UK investors capital gains tax treatment on disposal. Each UK investor will pay income tax on their share of the fund’s ‘reportable income’, regardless of whether or not a distribution is made. The advantage of having reporting status is that certification provides a marketing advantage for offshore funds wanting to distribute into the UK market. Previously, UK resident individual investors in offshore accumulation funds were unable to obtain the beneficial 18% capital gains tax rate on disposal of their shares. Under the new reporting regime, accumulation share classes can be certified because income only needs to be reported rather than distributed.
However, for those funds seeking to enter the new regime, it will not be without its challenges. To obtain certification as a reporting fund, an up-front application form must be submitted to HMRC for approval, containing two potentially onerous requirements.
1 The fund has to specify the entries in its accounts that are considered to equate to “total comprehensive income for the period”, as that is the wording used in IFRS. This is a potentially complex exercise, especially in cases where local Generally Accepted Accounting Principles (GAAPs) are in the early stages of convergence with IFRS, eg French and Luxembourg GAAP.
2 Where the fund does not account for the return from interest-bearing instruments under the ‘effective yield method’ as required by IFRS, it is required to either
adjust the reportable income calculation to follow effective yield principles, or use an alternative method that gives a materially similar result. The method chosen needs to be communicated to
HMRC through the up-front application, and is likely to impact on fund accounting systems.
To date, the decision to enter either the reporting status or distributor status regimes has hinged on the trade off for investors between the deferral of an income tax charge at 40%/50%, on both
the income and gains, and income taxed annually in the form of a distribution, but capital gains tax on disposal (currently 18% for individuals).
The Conservative-Liberal Democrat coalition has since made it clear that they “agree to seek a detailed agreement on taxing non-business capital gains at rates similar or close to those
applied to income, with generous exemptions for entrepreneurial business activities,” – an expression of intent to increase the capital gains tax rate from 18%. Therefore, this will
further affect the decision as to whether offshore funds should seek reporting status in order to attract UK investors.
Given the extensive consultation exercise that pre-dated the introduction of the reporting fund regime, it is hoped that the UK government will continue to support the investment management industry, for example, by treating the gain on a certified reporting fund as a qualifying business asset. The emergency Budget on 22 June will hopefully bring clarity.
Robert Mellor is a corporate tax partner at PricewaterhouseCoopers in the UK
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