Authorised investment funds technical releaseAugust 2012

The implementation of HMRC’s new reporting fund regime for offshore funds has, as expected, turned out to be one of the main on-going challenges in 2012 for managers and administrators of authorised funds. The fact that it was primarily intended to simplify the previous UK Distributor Status (‘UKDS’) Rules is an irony not lost on those who have had to deal with the ramifications. Regulations which were only released after two years of consultation and which have subsequently been updated four times in a relatively short period do not give much suggestion of a regime which is simple and straightforward.

Grant Thornton UK LLP has recently published the results of a research survey looking at the offshore funds industry’s perceptions of the regime to date (Grant Thornton UK LLP, Offshore Funds Survey, June 2012). In this survey only 22% of respondents believed that the new regime was less complicated than the regime which it has replaced. From the perspective of UK authorised funds investing in offshore funds however one wonders whether this percentage might even be lower. There has in recent years been a significant growth in the number of UK funds investing in collective investment schemes, both in multi asset class funds and in fund of fund structures, and given the breadth of the funds universe (and the growth in the demand for exposure to hedge fund strategies) a corresponding increase in the holding of offshore funds. The result has been an increased administrative burden, both in terms of the need to carry out on-going checking of the tax status of offshore funds but also the need to account for reported income, which in a conventional accounting sense is not a transaction as such and therefore not something which traditional accounting systems had been set up to handle.

None of this has simplified the environment from the perspective of a UK authorised fund investing in offshore funds and in this latest technical release we review some of the current issues from a UK fund’s point of view.

Wider definition of an offshore fundIn our survey, 17% of respondents indicated that HMRC’s new definition of offshore funds had resulted in more funds falling within the regime. For example ETFs clearly now fall within the regime and there are a growing number of identified examples of closed ended offshore investment companies (particularly in the Channel Islands where realisation vehicles can be common) which come within the technical tax definition of an offshore fund. The survey results do rather suggest that managers and administrators of UK authorised funds need to be alert to these wider possibilities as part of their screening processes.

Retrospective UKDS applications32% of respondents in the survey indicated that they had considered making retrospective applications for UKDS for funds which historically had not had this but which were now joining the new reporting fund regime. Managers and administrators of UK authorised funds may be wondering whether this opens up the possibility of being able to recover tax on offshore income gains paid in respect of disposals in prior years. There is a small window within which this

Investing in offshore funds

might be possible as the investing fund would have to make any claim for this within two years of the end of the accounting period in which the original gain was taxed. Thus for example a UK fund would have up until 31 December 2012 to be able to reclaim tax on an offshore income gain realised in the accounting year to 31 December 2010. This may however be worth checking for significant recent disposals.

Coupled with this is the need also to consider the possibility of making deemed disposal elections in respect of holdings in offshore funds which are going into the reporting fund regime for the first time having previously not had UKDS status and where no retrospective UKDS application has been made. For an investor to gain the benefit of reporting fund status the offshore fund must have had reporting fund status throughout the period over which it has been held. However the tax regulations make provision for the possibility of making an election for deemed disposal at the date of such a change in status – this may or may not crystallise a tax liability, taking into account any excess management expenses, but could be a way of ensuring that no tax is payable in respect of the entire period for which the offshore fund has had reporting fund status. Such elections might also be beneficial in situations where offshore funds cease to have reporting fund status. Each case would however need to be considered on its own merits.

Experience to date indicates that these are all live issues. Also, our survey suggests that offshore fund promoters are still in the process of making decisions as to reporting fund status and it may be some years until this settles down for existing funds. In this respect it is often necessary to understand the history of ownership of an offshore fund as well as its on-going status and whether that status has changed.

EqualisationThe demand for the ability for reporting funds to operate equalisation is reflected in our survey results which revealed that more than half of those responding were

operating equalisation in some shape or form. UK managers and administrators might therefore expect to find that equalisation is in relatively widespread use and this will impact particularly on those funds making regular offshore fund investments or those who choose to account for reported income on an estimated basis, where they consider that the circumstances warrant that approach.

Accounting for reported incomeThe guidance published by the IMA in May 2011 indicated that reported income should be accounted for not later than the date when the reporting fund makes its report available to investors. This gives some flexibility to any funds wishing to account for the income on an estimated basis and then adjust this when the reported income is known. Other funds may consider it appropriate to bring the income into account when it is reported.

Offshore funds have 6 months after the period end in which to report their income. The breaching provisions however are somewhat at odds with this - reporting up to four months late by an offshore fund is not considered to be a breach whilst a serious breach only arises where the reporting is 12 months late. In practice this may mean that some funds do not report by the 6 month deadline. Where this happens a UK investor fund will, by necessity, need to make an estimate of the reported income and bring this into account as for tax purposes the income arises 6 months after the offshore fund’s year end. It remains to be seen how widespread an issue this will become in practice.

Offshore funds are reporting their income using a variety of different methods. The majority of respondents (62%) to the survey favoured websites as their method of choice. Individual letters to investors (19%) and individual emails (12%) were indicated as being the next most widely used reporting formats. The lack of standardisation makes the administration more complex for investors but in the absence of any central repository this seems likely to continue for the foreseeable future.

One aspect of the new tax regime which we have seen attracting some interest is the ability for a fund with a holding in a non-reporting fund to choose to compute ‘deemed’ reportable income in order that the holding may be treated as if it were a reporting fund. Obtaining the relevant information, even if this incurs a cost, may in certain situations be highly preferable to paying tax on an offshore income gain, or may be helpful if a fund is in danger of inadvertently triggering the 50% threshold for automatic FINROF status. Although such situations will be the exception rather than the norm, having the facility to deem reported income is generally being viewed as helpful. For any funds taking advantage of this, it should be noted that whereas normally reported income is reflected in the financial statements as revenue (in accordance with the SORP), deemed reported income is reflected as an adjustment to the distribution (ie a transfer between capital and income, in accordance with COLL).

Philip ParsonsT 020 7865 2653E philip.parsons@uk.gt.com

Anne StopfordT 020 7865 2285E anne.stopford@uk.gt.com

Julian BartlettT 020 7865 2327E julian.bartlett@uk.gt.com

Accounting for deferred taxBecause timing differences between accounting and tax provisioning have reduced over recent years deferred tax is an area which has tended to reduce in significance and it can be easy to overlook. Offshore income gains can however potentially create both deferred tax assets and liabilities and have the capability to be material.

Funds without any management expenses to offset may have deferred tax liabilities in respect of unrealised gains on offshore funds. As a declining number of funds pay corporation tax many may however have surplus management expenses. The situation is complicated by the possibility that unutilised expenses could belong either to the capital or revenue of the fund when following the marginal method of allocating tax relief set out in paragraph 2.70 of the SORP. Some funds may in effect have a deferred tax liability in capital in respect of unrealised offshore income gains but a deferred tax asset in revenue arising from the ability to offset these gains with revenue expenses. Under the SORP deferred tax assets would not generally form part of any distribution until the asset crystallises however.

Funds offsetting surplus expenses against potential deferred tax liabilities on offshore income gains would need to build this into the deferred tax disclosures required by FRS 19.

Tax liabilities on offshore income gains, whether deferred or current, would generally be reflected as capital in calculating the distribution. Under the marginal method recommended by the SORP, the use of revenue expenses to reduce or eliminate any tax liability on offshore income gains can have the effect of increasing the distribution of the fund in the period in which the expenses are used.

ConclusionArguably one of the most immediate effects of HMRC’s search for tax simplification seems to involve having made the accounting and daily administration more complex for UK authorised funds investing in offshore funds. Our survey noted that since the inception of the new regime there has been an approximate 60% increase in the number of reporting funds compared with the number of funds registered for UKDS. Whilst this should mean greater tax certainty in general across the offshore funds universe it does seem to suggest that the systems needed to administer the identification and recording of reported income are going to be increasingly important.

Marcus SwalesT 020 7865 2320E marcus.swales@uk.gt.com

© 2012 Grant Thornton UK LLP. All rights reserved. ‘Grant Thornton’ means Grant Thornton UK LLP, a limited liability partnership. Grant Thornton is a member firm of Grant Thornton International Ltd (Grant Thornton International). References to ‘Grant Thornton’ are to the brand under which the Grant Thornton member firms operate and refer to one or more member firms, as the context requires. Grant Thornton International and the member firms are not a worldwide partnership. Services are delivered independently by member firms, which are not responsible for the services or activities of one another. Grant Thornton International does not provide services to clients. This publication has been prepared only as a guide. No responsibility can be accepted by us for loss occasioned to any person acting or refraining from acting as a result of any material in this publication.

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Contact usIf you would like to discuss any of the matters raised in thisrelease further, please contact one of our authorised funds experts listed below.

Alastair RobertsonT 020 7865 2275E alastair.robertson@uk.gt.com

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