Investments in offshore funds and the remittance basis

For non-domiciled UK-residents claiming the remittance basis of taxation is very
common to hold foreign investments.

These investments can include foreign currency, shares in foreign companies, debt
securities, art and offshore investment funds.

This article focuses on the taxation of offshore investment funds held personally by UK-
resident non-domiciled remittance basis users.

Offshore Fund

Offshore funds are part of a typical investment portfolio of individuals claiming the
remittance basis.

The definition of offshore fund is contained in s.355, TIOPA 2010 and includes:

(a) a mutual fund constituted by a body corporate resident outside the United Kingdom,
(b) a mutual fund under which property is held on trust for the participants where the
trustees of the property are not resident in the United Kingdom, or
(c) a mutual fund constituted by other arrangements that create rights in the nature of
co-ownership where the arrangements take effect by virtue of the law of a territory
outside the United Kingdom.

It is important to note that the section excludes partnerships from the definition.

Section 356 TIOPA 2010 defines a “mutual fund” for these purposes as arrangements
with respect to property of any description that enable the participants i) to participate in
the acquisition, holding, management or disposal of the property, or ii) to receive profits
or income arising from the acquisition, holding, management or disposal of the property
or sums paid out of such profits or income.

A further condition to be satisfied by the arrangements is that that the participants do
not have day-to-day control of the management of the property and the last one is that
a reasonable investor would expect to realise all or part of an investment in the
arrangements on a basis calculated entirely, or almost entirely, by reference to the
fund’s NAV or to an index.

A remittance basis user investing in an offshore fund usually assumes that any income
received by the fund or any gain realized on the disposal of his interest in it will be
exempt from tax in the UK unless a remittance occurs.

As usual in tax, things are not so simple and few considerations must be made to
establish whether income and gains deriving from the investment would be exempt from
UK tax, unless remitted, or are taxed on the arising basis.

Legal Form

The starting point is to identify the legal form of the fund to invest in.

As seen above, an offshore fund can be structured as a company, a unit trust scheme or
other arrangements which create rights in the nature of co-ownership.

The legal form of the fund is important to determine whether it may be considered
opaque of transparent for UK tax purposes.

HMRC has published a list of foreign entities and their classification for UK tax purposes
to clarify how a member is to be taxed on the income they derive from their interest in
the entity.

Unsurprisingly the list is not exhaustive and for entities that are not mentioned an in-
depth study is required to understand whether they may be regarded as opaque or
transparent for UK tax purposes.

If an entity is regarded “opaque” for tax purposes, any profit will be taxed at the entity’s
level and at the investor’s level only if distributed.
There is an exception to this rule when a fund has a “reporting status”.
An investor or participator in an entity regarded “transparent” for tax purposes will be
taxed based on his entitlement to profits regardless of whether a distribution has been
declared.

Reporting and Non-Reporting Funds

An offshore fund organized as a non-UK resident company should be treated as opaque
for tax purposes, as seen above.

Therefore, there are two types of offshore funds, reporting and non-reporting funds.

An offshore fund which satisfies certain conditions can make an application to HMRC to
gain reporting fund status.

When a fund has a reporting status its undistributed income is taxed as distributed in the
hands of its investors. Basically the fund is treated as transparent for tax purposes even
if the fund is structured as a corporate entity.

The positive side of having a reporting status is that any disposal or redemption of an
interest by the investor will be taxed in accordance to CGT rules.

On the other hand, when investing in a non-reporting offshore fund, an investor will not
be taxed on undistributed fund’s income but any gain on redemption or disposal of an
interest in it will be an offshore income gain and even if computed according to CGT
rules, it will be subject to the less favourable income tax rates.

The remittance basis

The remittance basis is available to remittance basis users investing in offshore funds.
As seen before offshore funds can be structured as open-ended companies, partnerships,
unit trusts or contractual schemes.

Shares in non-UK corporate funds are, according to common law principles, situated
where the company’s share register is held.

This means that a gain on the disposal of shares in a reporting offshore fund will be a
foreign gain if the company’s share register is held outside of the UK and will be subject
to remittance basis rules.

In case of a non-reporting fund, a gain realised on the disposal of an interest is taxable
as income in the hands of the investor but it will be non-UK source income and therefore
qualify for the remittance basis.

If the fund makes distributions to investors, as the company is non-UK resident, that
income will be non-UK source.

The same principle applies to reporting funds undistributed profits that are attributed to
its investors.

If the fund is a corporate entity regarded opaque for UK tax purposes, the location of the
source of income it receives, whether UK or foreign, does not affect the use of the
remittance basis.

For a remittance basis user it is probably more suitable to invest in reporting funds if he
or she is planning to make remittances in the future because any disposal of an interest
will be taxed at CGT rates and actual income distributed by the fund could potentially be
segregated.

Some offshore funds can be transparent with respect to their income or both income and
gains.

This is the case especially with foreign partnerships which are usually fully transparent
for income tax and CGT.

In this case it will be important to make sure that the fund does not invest in any
underlying UK investment.

In regard to unit trusts funds, these are classified as transparent for income tax
purposes if they qualify as Baker trusts.

They do so if the trust instrument gives a unit holder an unqualified entitlement to a pro-
rata share of the net income of the trust and the law governing the trust follows English
law in treating such an entitlement as an equitable interest in the income.

The remittance basis is a great tool available to UK resident individuals who want to
invest in offshore investment funds without being taxed on income received or the gain
realized on the disposal of an interest in the investment.

Therefore it is important to understand the structure of the fund and most of the time is
advisable to invest in those structured as non-UK foreign companies to benefit from their
opaque tax status.

In this case attention must also be paid to the reporting or non-reporting status of the
fund especially if any remittance of foreign income or gain will be necessary.

When an offshore fund takes the form of a partnership, unit trust or a contractual
scheme and will be regarded transparent for UK tax purposes care needs to be taken to
make sure that it does not hold any underlying UK investment.