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Liability of the land

In recent weeks, I have looked at the potential changes to the definitions of residence and domicile that may emerge from the review announced in this year&#39s Budget and also to the taxation of offshore funds as a result of the consultation document published shortly after the Budget.

The results of both the review and consultation should be considered carefully by financial advisers involved in giving advice where any changes to the definition of residence and/or domicile could impact on the appropriateness of investment recommendations.

Potential changes to the taxation of offshore funds may have an impact on more clients than the domicile/residence rules. While offshore funds (and non-distributor/roll-up funds, in particular) may not be top of the recommended products list for many clients, they cannot be ignored completely.

Under current rules, however, offshore distributor funds appear to offer little in the way of tax benefit for UK-resident investors. Capital gains made by the fund manager on disposals of the investments underlying the fund, such as shares or investments in other collectives, will usually be free of capital gains tax. But this offers no advantage over the UK fund manager of an authorised unit trust, Oeic or investment trust, as all gains made by such a manager on disposals of underlying shares are also CGT-free.

When it comes to income, the offshore distributor fund will usually receive dividends from its equity or fund investments net of withholding tax. Even where no withholding tax is suffered, it must be remembered that, in most cases, a dividend is paid out of profits that have been subject to some level of tax at the corporate level. Because of this, dividends received from a UK company by an offshore fund will be the same amount as those paid by the company to a UK fund. Although advance corporation tax has been abolished, dividends will continue to be paid in most cases from post-tax profits so that the corporation tax liability of the company on its profits will impact on the level of dividend paid. Dividends will be paid with a tax credit of 10 per cent but this cannot be reclaimed by a non-resident fund.

UK funds receiving dividends from UK companies will receive them as franked income on which they are not liable to corporation tax and no reclaim of the credit can be made. This means that the net dividend received by the offshore fund will be the same as that received by the UK fund.

Given the lack of many double-tax agreements between tax haven countries and other countries (subject to some exceptions), it is unlikely that there will be any reclaim possible for offshore fund managers.

When it comes to interest, this will usually be received gross by the offshore fund and there will be no tax at fund level. The UK fund would have a liability to corporation tax at 20 per cent.

On the payment of dividends from an offshore fund, no deduction will be made by the fund manager.

However, the UK-resident recipient will have a UK tax liability on the dividend received unless he is a non-taxpayer and the dividend does not take his income over the personal allowance.

For a UK-resident individual receiving equity dividends from a UK fund, the dividend will be received with a 10 per cent tax credit. Non-taxpayers can make no tax reclaim while 10 per cent and basic-rate taxpayers will have no further liability. Higher-rate taxpayers will have a liability on the grossed-up dividend (taking account of the 10 per cent tax credit) at the rate of 32.5 per cent. The tax credit of 10 per cent can then be taken off the amount arrived at to determine the amount of tax actually payable.

For UK investors, the offshore distributor fund would seem to offer little in the way of tax benefit compared with the UK fund. However, investment decisions will not be made on tax grounds alone. Issues such as fund choice, investment performance and charges impact on suitability.

When it comes to non-distributor funds, the benefits of tax deferment and simpler year-on-year administration will be key attractions to UK investors who value these features. These funds are undoubtedly less prevalent in the UK retail market than, say, offshore insurance bonds that deliver similar features.

In comparing offshore bonds and roll-up funds, it is essential (apart from a careful comparison of investment performance, fund choice and charges) to be aware of the substantially different tax treatment of the emerging benefits from the two products.

This is especially so since, during the course of the investment, both the offshore bond and the offshore fund offer investment roll-up free of any personal tax liabilities for the investor and, thus, simple tax administration due to the lack of any need for an investor to submit details in respect of the bond or fund in his or her tax return until a gain is made.

Next week, I will compare offshore roll-up funds and offshore bonds, under the current legislation, on tax grounds.

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