When it comes to considering pension alternatives, especially where doing so is tax-motivated, it is essential to know in some detail how the tax operates at both fund and investor levels.
The taxation of UK capital investment bonds, offshore capital investment bonds and UK collectives is relatively well known. However, the 2009 Budget proposed changes that will affect some of the latter alongside the less well known and less well used offshore funds.
The tax-elected fund proposals are worth knowing about when the fund chosen makes investments that generate interest at fund level but do not qualify to pay an interest distribution.
Under current rules, UK authorised investment funds (Aifs) are normally chargeable to corporation tax on taxable, that is, non-dividend, income at a special rate of 20 per cent.
That will remain the case under the new regime but UK Aifs that meet certain conditions will be allowed to choose to be treated as a tax-elected fund (Tef). Tefs will be required to make two types of distribution of the income they receive – a dividend and non-dividend (interest) distribution.
UK dividend income will remain non-taxable in the fund and will be distributed as a dividend. For all other income that is distributed as a non-dividend distribution, the fund will receive a tax deduction of up to the same amount. The new regime will be introduced by secondary legislation.
UK investors receiving returns from these Tefs will be treated as receiving UK dividend income, including the non-payable 10 per cent dividend tax credit, and a payment of yearly interest in the appropriate proportions.
An associated change applies to investment trust companies. They too will be able to stream interest, receiving a credit at company level for tax paid on interest received with “transparency” – in effect, being provided for investors who will previously have only received a 10 per cent non-payable tax credit on the dividend received from the investment trust company.
Important adjustments have also been proposed for offshore distributor/ reporting funds.
These are part of those changes proposed to the taxation of dividends from offshore companies. I will look separately at dividends paid to individuals from offshore companies (which are not offshore funds) and those from offshore funds.
Starting with those paid from offshore companies, when dividends from UK resident companies are charged to tax, shareholders are entitled to a non-payable 10 per cent tax credit of one-ninth of the distribution under the provisions of section 397(1) of the Income Tax (Trading and Other Income) Act 2005 (ITTOIA).
Because tax is charged on the gross dividend received, including the tax credit, this lowers the effective rate on these dividends at the personal level to 0 per cent for basic-rate taxpayers and 25 per cent for those paying a higher rate.
Section 397A of ITTOIA, introduced by the Finance Act 2008, extended the non-payable tax credit of one-ninth of the distribution to individuals in receipt of dividends from non-UK- resident companies. This is dependent on them owning less than a 10 per cent shareholding in the distributing non-UK resident company, regardless of the territory in which the company is resident and provided the company is not an offshore fund.
Legislation in Finance Bill 2009 amends section 397A of ITTOIA to extend further eligibility for the non-payable tax credit to individuals in receipt of dividends from non-UK resident companies where the individual owns a 10 per cent or greater shareholding in the distributing non-UK resident company.
However, the tax credit will only be available if the source country is a “qualifying territory”, meaning there is a double-taxation agreement with the UK together with a non-discrimination article. Regulations will allow HM Treasury to vary the list of qualifying and non-qualifying territories. Luxemburg and Ireland are, for example, qualifying territories.
I will take a look at the new rules for offshore funds paying dividends next week.