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Offshore objectives

Having looked at the current rules on domicile and residence, and assessed the potential outcome of the forthcoming review of those rules, I would now like to turn to the consultation on the taxation of offshore bonds.

The consultation document starts with a clear summary of the scope and intention of the review. It is made clear that, in the Inland Revenue&#39s view, the time has come to review the appropriateness of legislation that dates from 1984 (the offshore funds regime) and whose aim was to prevent investors using such funds to reduce or eliminate tax they would otherwise pay on savings income.

The Government&#39s aim is the same today – that investors should pay tax on their investments in offshore funds to the same extent as they do in comparable products such as UK-based unit trusts and Oeics.

The Government is, however, committed to taking into account the needs of investment providers and investors. It is also committed to promoting simplicity without undue compliance burdens. Additionally, it wishes to enable the fund management industry to promote its funds without undue compliance burdens in Europe and other major international markets.

Responses are sought by July 31, 2002, after which a further document, which will take into account the representations made and include draft clauses for further consultation, is planned.

The objectives are stated to be to ensure that:

•UK investors are taxed fairly on savings and investments.

•Appropriate account is taken of market and business factors and, in particular, the significant commercial developments since 1984, when the current offshore funds regime was introduced.

•The UK remains an attractive place for funds business.

•UK-based funds, as well as those based offshore, are not made uncompetitive.

•Proper account is taken of other developments in UK tax legislation.

•As far as possible, any changes in tax law that are made as a result of the review are simple to understand and operate and that UK investors and fund managers are not faced with costly compliance pressures.

It is important, I think, to understand the background to the consultation. The following is a summary.

Basic legislation was introduced in 1984. The legislation aimed mainly to counter the use of particular funds to convert income flows to capital gains because, in 1984, the difference in the taxation of income and capital gains was significant. Despite some convergence, the capital gains tax rules remain more generous to this day.

The 1984 rules introduced the concept of qualifying and non-qualifying funds. For qualifying funds, the tax treatment is the same as UK funds. For non-qualifying funds, there is no difference in the tax treatment of returns from income or gains and the purpose of the regime is to set aside the legal form of the realisation (ignoring the fact that gains may have been constituted by both gains and income) and treat all gains arising on the disposal as income.

Approval as a qualifying fund depends on the fund manager making an application to the Revenue for distributor status. A range of conditions must be met, most important of which is the requirement that the fund distributes at least 85 per cent of its income. Approval is only given retrospectively and must be secured for each period of account.

Investors will only be able to secure CGT treatment on their holdings if the fund in which they have invested has met all the conditions for approval throughout their period of investment. For umbrella funds, the fund as a whole and each class of share must satisfy the conditions before the fund can be qualifying.

The Ucits directive permits the marketing of unit trusts and Oeics from one European country to another, so to have different administration requirements (for example, the need to obtain distributor status) in different jurisdictions is not conducive to the avoidance of administration burdens.

There have been developments in the taxation of UK funds but offshore fund legislation remains largely unchanged. The choices identified in the consultation document are:

•No change.

•Abolition, meaning no difference between UK and non-UK funds.

•Amendments to the existing regime.

•An alternative regime.

The possibilities, based on these choices, appear to be as follows:

The first two choices are self-explanatory. It seems, however, that repeal or abolition is unattractive to the Government. The main reason given is that, as a corollary to repeal, the Government feels that there would be a necessity for investors to report income on an arising basis from an offshore fund. This would be administratively burdensome (not to say difficult) for investors in roll-up or non-distributor funds.

There is also significant concern over the greater opportunity to convert income to capital gains so as to gain what the Revenue views as an unfair tax advantage. Taper relief, for example, applies to capital gains and not income.

Next week, I will look at the possible implications of the other two choices, that is, reform and replacement.

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