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International taxation | 11
‘bed and breakfast’ rules which can set a new ‘Reporting Fund’ status: again, problematic in UK terms as it may be
aside transactions in relation to the same offshore funds with Reporting Fund status impossible to separate out the capital and
investments within a 30 day period. will offer CGT treatment on gains and so income that is returned in a mixed receipt.
It should be noted that non-US will be more UK tax efficient than non- This can make tax reporting difficult for
companies can be treated as so called Reporting Fund status funds. UK investors.
‘PFICs’ which can result in adverse US tax 4.2 US treatment 5.2 US treatment
implications (discussed at section 4.2 The Passive Foreign Investment Companies The US has a highly sophisticated set of
below). (‘PFICs’) rules can make non-US corporate rules dealing with the taxation of
funds very unattractive investments for US partnerships. In their most basic form, like
3. US mutual funds tax purposes. Many offshore funds the UK, these rules result in the partners
As a result of the disadvantageous regime structured as companies may be within the being taxable annually on their share of
that applies to US persons investing in scope of the US PFIC rules: classification as partnership income and gains. Almost all
non-US funds (see section 4 below), US a PFIC occurs when 75% or more of the US hedge and equity funds are structured
mutual funds are very popular company's income is passive or when more either as partnerships or limited liability
investments for US persons. In practice, than 50% of the company's assets exist in companies which are taxable as
mutual funds distribute (via ‘dividends’) investments earning interest, dividends, partnerships for US tax purposes.
their annual income and net capital gains. and/or capital gains.
Due to special US tax rules for mutual Where a US person owns a PFIC directly 6. Bonds
funds, investors are entitled to treat these (or is deemed to have an indirect 6.1 UK treatment
dividends as being comprised of the ownership interest), he must include as Interest paid on Government or corporate
underlying types of income and gains ordinary income (i.e. the 35% rate) the bonds is subject to income tax in the UK;
comprising the dividend. Thus the allocated gains or excess distributions in its proceeds of the sale of bonds or their
portion of the dividend comprised of net gross income for the taxable years in which redemption will be a CGT receipt.
capital gains can be eligible for favourable the allocations are made. The tax liability is Where a bond can be redeemed (either at
15% rates. determined at the highest rate of tax in maturity or upon any earlier date) at more
Gains on sales of mutual fund investments effect for the applicable taxable year. than its initial issue price, it may constitute
will be taxed at 15% where held for more Additionally, the deferred tax liability from a deeply discounted bond for UK tax
than 12 months or ordinary income rates the allocations are treated as purposes; this will result in the investor
if held for 12 months or less. US mutual underpayments of tax, and interest charges incurring a UK income tax charge on the
funds will, however, invariably be offshore are imposed on the deferred taxes on the gain.
funds for UK purposes (considered below allocated gains and excess distributions. 6.2 US treatment
at section 4). These mutual funds will not Where a fund is a PFIC and has significant If the bonds do not bear adequate interest,
qualify for UK distributor (or new accumulated income, the effective rate of US rules can reclassify a portion of the
‘electing fund’) status unless the necessary tax with the interest charges can be very return from capital gain (15%) to ordinary
elections are actually filed in the UK. significant although it will (ultimately) be income (35%). Zero-coupon bonds would
capped at 100% of the amount of returns be an example of a portion of the return
4. Offshore funds received. being reclassified as interest from the US
4.1 UK treatment It can be possible to invest in a corporate perspective.
The offshore funds regime in the UK fund without such adverse US tax issues if Although the UK and the US rates of tax on
applies to any ‘collective investment the fund elects to be treated as a income and gains are broadly similar presently,
scheme’ which includes OEICs, unit partnership for US tax purposes or if the the increase in the higher rate of UK income
trusts, SICAVs, ETFs and, in practice, investor makes a qualifying elective fund tax to 50% next year will significantly change
most other collective investment vehicles (QEF) election in which case the investor the position. In any event, the two tax systems
other than partnerships whether or not pays tax on his share of the income and do not necessarily attribute the same treatment
the investment management takes place gains in the fund on an annual basis. to the same investment types: although a UK
within the UK. investor in an offshore fund with distributor
The effect of this regime is, in summary, 5. Partnerships status will benefit from CGT treatment on their
that where an investor places money with 5.1 UK treatment investment, from a US perspective it may be a
a collective offshore fund without Some types of collective investment PFIC and the effective tax rate might easily be
‘distributor status’, gains ultimately scheme (typically private equity fund 70% - 80%: while the UK/US double tax treaty
realised will be taxed as income rather arrangements) are structured as might provide a credit against double taxation,
than as capital (i.e. 40% rather than 18%). partnerships which are generally it will not normally prevent the difference
Dividend and/or interest payments considered to be outside the scope of the between the two rate being chargeable. By way
received will be treated as income. It is UK offshore fund rules. Partnerships are of another example, a US mutual fund will
important, therefore, to establish before generally ‘look through’ for UK tax represent a very tax efficient investment for US
any investment in an offshore fund is purposes and therefore an investor will be investors offering a 15% rate for long-term
made whether the fund has distributor liable on an arising basis to all income and investors but for UK investors many such funds
status. Where there is a choice between capital generated within the partnership will be offshore funds without distributor
two similar offshore funds, one with whether or not these income and gains are status and so, from April 2009, gains on them
distributor status will be significantly distributed to them. will potentially be subject to tax at a 50% rate.
more tax efficient from a UK perspective. Partnership investments in which there is To avoid double tax charges and to try to
It should be noted that with effect from 1 no facility to influence how the underlying achieve efficient results, investors with UK
December 2009, the UK ‘distributor investments are run and in which there is and US exposures need to take particular care
status’ fund regime is being replaced with little access to information are very in selecting their investments.
www.investmentinternational.com September 2009 Investment International
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