The taxation of income and gains generated in offshore funds is complex but distinct.
Where a UK resident taxpayer has offshore investments, it is important to identify and apply the correct tax treatment. Where this is not identified, the taxpayer could find themselves overpaying a significant amount of tax or underpaying a significant amount of tax and undertaking a costly exercise to untangle, disclose and pay the correct amount of tax.
When assessing the correct tax treatment applicable to a particular offshore fund, the taxpayer must identify which of the following categories his or her investments fall into:
- Transparent Funds;
- Opaque Funds with Reporting Status; and,
- Opaque Funds with non-Reporting Status.
A transparent fund is defined as one where any income of the fund is taxable on investors directly and consequently, is taxable on an arising basis.
Generally, the key identifiable difference between a transparent fund and an opaque fund is that, in opaque funds investors are regarded as owning units in the fund and comparatively, in opaque funds, the investor is regarded as owning a share of the underlying fund assets.
Where a fund is not transparent, you must also consider whether the fund has ‘Reporting’ or ‘non-Reporting’ status.
Opaque Funds with Reporting Status
A reporting fund is a fund that reports the details of its income to HMRC and investors within 6-months of the end of each accounting period.
All income arising to investors is taxable on an arising basis, whether or not it is actually paid to investors and is according to the source of income, such as dividend, interest, etc.
Where units of funds are disposed of, these are chargeable to capital gains tax on an arising basis.
Opaque Funds with non-Reporting Status
Non-reporting funds are not required to provide HMRC with the details of its income, or any other information.
In comparison to reporting funds, income is not taxable on an arising basis, where it is undistributed.
Similarly, where units of funds are disposed of, these are not taxable to capital gains tax, instead these are taxable to miscellaneous income, referred to as offshore-income gains. The purpose behind this is to prevent funds rolling up income to increase the underlying value of the fund, which could then be disposed of and taxed according to capital gains tax, usually at a lower rate.
Where losses are made, these losses cannot be used against offshore-income gains and may only be used against capital gains, such as gains made on funds with reporting status.
- It would be prudent to consider any investment strategy in light of the tax implications of such investments and work with an adviser that is also mindful of the applicable UK tax rules. Where the relevant tax are not considered, misunderstood or unknown, it is likely that income or gains may be misrepresented or omitted, which may result in a difficult, lengthy and expensive exercise in correcting the applicable tax treatment. Notably, where this occurs in relation to investments in 2018 onwards, taxpayers would be subject to an automatic Failure to Correct (‘FTC’) penalty of 200% on the potential lost revenue, which may only be reduced by a maximum of 100%.
- Succession planning is vital when holding investments in non-reporting funds. Specifically, there is no exemption where an investor dies holding such investments and instead, death will be treated as a taxable event for the purposes of offshore-income gains and subject to the likely higher rates of income tax. As a result, investors should keep this in mind when adopting an investment strategy, so as to seek to limit any exposure to such higher rates of tax, which could result in an effective rate if tax in excess of the inheritance tax rate.
- An investor should understand any additional and connected consequences of such investments. For example, it is worth noting whether tax is payable on any investments in the overseas jurisdiction, if so, how much, and identify whether and how you will get double tax relief on any tax paid, whether in the UK or overseas. Notably, this may be an expensive omission where a taxpayer is seeking to rectify an error made previously, having established that tax may have been paid in a jurisdiction that did not have the primary taxing rights and it is too late to recover the tax paid, resulting in double taxation.
At ETC Tax we have an experienced and specialist team who have developed particular expertise in relation to the taxation of offshore investments, which includes assessing the correct and applicable treatment, calculating the relevant tax payable, identifying the taxing rights between relevant jurisdictions and assisting clients in submitting disclosures to HMRC.
If you or your client has or intends to invest in offshore funds and would like assistance with this, then please get in touch.