The landscape has changed for those wishing to establish a fund in the UK. Amendments to the tax regime applying to UK funds, combined with other corporate tax changes, has made it a prime location to domicile a fund.
The UK has always been an attractive location to establish a fund from a non-tax perspective, due to its well developed and business friendly legal, regulatory and control framework. In addition, the UK has always had a particularly extensive network of bilateral double taxation agreements (DTAs) (with more than 100 countries) which means that withholding taxes suffered on dividends earned globally can often be lower than other fund locations.
However, these factors were often outweighed by the UK's tax regime applying to funds.
Following extensive consultation between the Government and the financial sector, the tax regime for UK funds has been changed, while at the same time there have been other positive developments to the UK's taxation of foreign profits. Most of the changes come with conditions, in particular for funds, the requirement for diversification of ownership and distribution of income. However, for most funds, this should not be a problem.
These changes make the UK broadly comparable to other 'good' locations from a tax perspective, arguably making it a very desirable location to establish an investment fund all things considered.
We have briefly outlined the changes to the tax regime below.
Taxation of Dividends Received
From 1 July 2009, most dividends received by an open-ended investment company (OEIC) or authorised unit trust (AUT) are not subject to UK corporation tax in the fund. This will significantly reduce or eliminate the tax payable by a fund investing in equities and make such funds comparable to non-UK funds in most cases.
Capital v Trading Transactions
Capital gains have been exempt from tax in OEICs and AUTs for years. However, there has always been a degree of uncertainty over whether a transaction would be regarded as a capital or trading transaction. To deal with this uncertainty, HMRC has issued a comprehensive list of instruments, the investment transactions in which will be taxed as investment activity and not trading activity, the so called 'white list'. For the white list to apply, the fund must meet 'equivalence' and 'genuine diversity of ownership' conditions. Funds meeting the conditions will therefore have a high degree of certainty that they will be exempt from tax on their capital gains on white list transactions.
Property Authorised Investment Funds
The property authorised investment fund (PAIF) tax regime was introduced on 6 April 2008 and provides for tax-efficient investment into property through an authorised investment fund structure and is comparable to the real estate investment trust (REIT) regime applying to corporate structures (which was introduced on 1 January 2007). Subject to satisfying the conditions, the fund does not pay tax on income received. As with REITs the tax liability is passed to the investor. The PAIF regime therefore ensures that tax exempt investors do not suffer taxation in the fund that cannot be recovered.
Tax Elected Funds and Funds Investing in Non-Reporting Offshore Funds
The tax elected fund (TEF) and funds investing in non-reporting offshore funds (FINROF) regime now provide increased flexibility to transfer the liability for income tax from the fund to the investor, potentially reducing the risk of lost tax, particularly for non-taxpaying and non-UK resident investors.
Funds that do not satisfy the investment conditions to be treated as 'bond funds', but that satisfy certain other conditions, including genuine diversity of ownership, can now elect for TEF status and treat part of their distributions to investors as being tax deductible in the fund in a similar way to 'bond funds'. This element of the distribution will be treated as a payment of yearly interest and may have to be paid net of tax. This effectively passes the liability for tax on that element of income from the fund to the investor.
For accounting periods commencing on, or after 6 March 2010, UK funds with more than 20% of gross assets invested in non-reporting funds will be taxed as FINROF. Responsibility for tax on fund performance (as an offshore income gain) shifts from the fund to the investor. UK funds with 20% or less of gross assets invested in non-reporting funds can elect to be treated as FINROF.
The advantage of this tax status for a nontax payer or non-UK resident should be no UK tax liability, however the implications of FINROF status for tax paying UK investors will need to be considered.
In Summary
These recent changes make the UK a much more attractive regime to domicile a fund. Taking into consideration the tax and non-tax advantages noted above, the UK should be considered as a location of choice for many investment funds.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
