The UK Reporting Fund Regime

The UK Reporting Fund regime came into force with the intention of simplifying the rules attached to its predecessor, the UK Distributor Status regime, principally by removing the obligation to pay dividends in the event that an offshore fund had net income in a particular period. Both regimes provide the ability for offshore funds, where they qualify, to be treated on a similar tax basis to UK funds as opposed to a punitive tax treatment which will apply to offshore funds outside the regime.

Having passed the second anniversary of the introduction of the UK Reporting Fund regime for offshore funds, it is timely to review the first annual reporting cycle.

Before doing so, it is worth reviewing the most significant amendments to the original Offshore Funds regulations which came into force last year. These included:

  • Imposing a requirement on all funds to confirm whether they operate equalization arrangements on undistributed income on the occasion of subscriptions and redemptions. The fund is then obliged to elect from a variety of options regarding the basis on which it calculates and reports reportable income to investors. Whilst this election could be dis-applied in respect of periods ending prior to the amended regulations coming into force, we generally entered into detailed discussions with clients to determine what would be the most appropriate election to make, seeking to balance being as equitable as possible in apportioning reportable income to investors whilst not over complicating the calculation of reportable income itself (which may be possible depending on the option elected).
  • Setting out the framework to enable transparent funds (ie FCPs) to calculate reportable income on a comparable basis to non-transparent funds (ie OEICs). Our experience shows that a number of uncertainties remain in this area and we remain in discussion with HMRC in seeking clarification on specific points.
  • Enabling private equity structures to fall outside the regime on the basis that certain qualifying conditions are met.
  • Widening access to the “white list” of investment transactions. This list covers most typical transactions undertaken by a fund and provides certainty to the fund confirming treatment of gains as investment gains for tax purposes as opposed to trading profits. The “ white list” has been extended to certain funds constituted in EEA states provided they are required to limit their borrowing and exposure to derivatives and forward transactions to 100% of the fund’s NAV. While this extension is to be welcomed, it seems inequitable that an offshore fund in one jurisdiction may be considered to be investing, and another fund pursuing an identical strategy in another country could be deemed to be trading for UK tax purposes by virtue of these rules, and hope that industry representations in this area will be heeded by HMRC in the near future.
  • Clarification that reports only need to be made to UK tax resident investors and other reporting funds, ie only investors that would need to rely on the calculation and reporting of reportable income.
  • Confirming that the taxable date for investors will typically be six months following the end of the period, irrespective of when the report is made available by the fund. Again, this is to be welcomed as, under the original regulations, if the reports were not issued within six months of the end of the period, then the tax point for the investors was deemed to be the last day of the period. This could have caused adverse consequences for investors on the basis it could accelerate the point of taxation to an earlier tax year depending on the fund’s balance date.
  • Extending the time limit for making the one off up-front application for UK Reporting Fund Status (UKRFS) to the later of (a) the end of a period of account, and (b) three months from the issuance of the class of interest. This is a welcome relaxation in comparison to the requirement under the original regulations to, broadly, make an application within three months of the beginning of the period of account or launch of the class of interest, and should thus reduce the likelihood of funds missing the deadline for obtaining UKRFS from the date they require.

Our experience indicates that the first annual reporting process for the vast majority of our offshore funds passed smoothly. Acknowledgement should also be passed to fund administrators who were generally able to produce a detailed analysis of income, expenses and gains on a per class of interest basis (which is required in order to compute reportable income for each class of interest with UKRFS). Aside from the considerations set out above, one of the more prominent on-going issues has concerned obtaining a detailed analysis of amounts on a per series basis (as an individual series within a share class is currently considered a separate class of interest for UKRFS purposes) which potentially increases the burden for advisers and administrators alike. The recent release of the updated Offshore Funds Manual by HMRC has provided some relief and clarification in this area by treating the funds as if they are a single fund in certain circumstances and where various series are collapsed into one share class at the end of a reporting period, only one figure of reportable income will be required to computed for that share class.

On some occasions, once the review of income and expenses for each class has been undertaken to adjust for capital items (as defined under the Regulations), consideration also needs to be given as to whether investments have been made in other offshore funds. In some cases, it is apparent that the strategy pursued by the fund should result in this not being in point, ie where a fund only invests in equities. For other funds, it may not be so straightforward.

The reason is that the definition of an offshore fund under the Regulations is fairly broad and is concerned with the characteristics of an offshore vehicle which principally enables an investor to realize an investment by reference to NAV or an index of any description. Whilst there is currently no list of prescribed offshore vehicles that fall within the definition of an offshore fund for the purposes of the Reporting Fund regime, it can be generally assumed that OEICs, open-ended contractual arrangements, foreign unit trusts and certain arrangements with limited life will do so. Various consequences can arise for a reporting fund investing in another offshore fund. Where the underlying offshore fund has UKRFS, then the reporting fund can simply rely on the provision of reports on annual basis to determine whether any excess reported income should be included in their own calculation. In contrast, where the underlying fund does not have UKRFS, then the reporting fund is required to either (a) obtain sufficient information to enable them to perform a calculation of reportable income of the underlying fund (which may not be feasible in many cases for commercial sensitivity reasons), or otherwise (b) treat any fair value increase in the investment in the underlying fund as income in computing its own reportable income, which may be considered commercially unattractive. In view o f this, subject to commercial and other investment drivers, we would always advise that reporting funds give due consideration to UKRFS consequences where making investments in other “funds” and determine whether the underlying investment (if it does fall within the definition of an offshore fund) has UKRFS in order to manage the possibility of gains being considered income for UK tax purposes under the Reporting Fund regime.

Following the finalization of the calculation of reportable income, it is important that the fund manager determines whether they or the fund’s administrator will take responsibility for issuing the reports to the “relevant” investors (i.e. UK resident taxpayers and other reporting funds). The Regulations have been drafted with the intention of seeking to minimize the administrative burden, such that actual distributions (if any) and excess reported income (i.e. the notional distribution deemed to arise from the calculation of reportable income) can be reported on a per unit basis obviating the need to personalize reports for each affected investor. Regardless of whether a manager wishes to personalize the report or not, there are many options available to communicate with investors, the most common of which are via post, email (with suitable attachments) or on a publicly available web-page. Whilst advisors may, on behalf of clients file the required information with HMRC, it is critical that, prior to this event, the report is made available to investors as this is one of the documents that needs to be included in the submission pack to HMRC. As such, the fund manager should be clear as to whether they will send the reports to investors and, if so, be capable of identifying who the relevant investors are and ensure communication is made in the correct form on a timely basis.

Finally, if reportable income is reported to investors, the manager needs to decide whether they wish to make a distribution in order to avoid the investor receiving a dry tax charge. The quantum and timing of this distribution is important and it should fall into the same corresponding tax year as the reportable income. In our experience it is efficient to understand early in the process the likely reportable income so directors can consider declaring a dividend at the time of signing the fund’s financial statements.

In summary, the majority of amendments to the regulations have eased the application and annual reporting process, and we would strongly advise offshore funds with UK investors not currently in the regime to consider obtaining UKRFS, where appropriate. This is especially so in view of the on-going disparity between income tax (up to 50%) and capital gains tax (28%) rates.

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