IFM12142 - Offshore Funds: Overview of the offshore fund rules: introduction

The tax regime for UK investors in offshore funds, introduced in 1984, was established on the basis that, if an offshore fund did not distribute at least 85% of its income then, on disposal of interests in the fund, UK investors would be charged to tax on income rather than on capital gains. This was to prevent the possibility of rolling up income in an offshore fund with any subsequent disposal being subject only to tax on capital gains, rather than being charged to tax as income.

The rules were substantially revised in 2009. The concept of a ‘distributing fund’ was replaced with that of a ‘reporting fund’. This was to accommodate accumulation funds that do not have a policy of distributing cash to investors. Under the current rules, capital gains treatment will only be available to UK investors if an offshore fund’s income is reported to them in a way that they are charged to tax on their share of the ‘reported income’ of the fund, regardless of whether that income is distributed to them or is accumulated in the fund. In that case, when they dispose of their units gains which have not been taxed as income are chargeable gains. Under these rules, offshore funds are either ‘reporting funds’ or ‘non-reporting funds’ – reporting funds being those that calculate income in a prescribed way and report it to UK investors.

The current definition of an offshore fund is contained within S355 TIOPA 2010. It detaches the tax definition of an offshore fund from the regulatory definition of ‘collective investment scheme’ and is based on characteristics. The detailed operational rules relating to the treatment of UK investors are contained within the Offshore Fund (Tax) Regulations 2009 (S.I. 2009/3001). The key features of the regime for offshore funds rules include:

• a tax definition of an offshore fund (section 355 TIOPA 2010);
• a facility for an advance application to be a reporting fund;
• a requirement for reporting funds to report fund income to UK investors rather than the requirement to distribute income;
• the consideration of only one ‘layer’ of funds for reporting funds: there are neither percentage investment restrictions nor a limit to the number of ‘layers’ of funds into which a reporting fund can invest;
• revised rules to deal with breaches of conditions, in particular to deal with occasions of minor or inadvertent breaches; and
• taxing disposals of units by most UK investors in non-reporting funds as income gains.

This part of the Investment Funds Manual provides guidance on the definition of an offshore fund (see IFM12210 onwards), and the detailed rules relating to the operation of the regime contained within the Regulations (see IFM12400 onwards).