Clause 39
Finance Bill
6:45 pm
Mark Hoban (Shadow Minister, Treasury; Fareham, Conservative)
I will give some background before dealing with the individual amendments. Clause 39 deals with a technical aspect of the rules and is meant to tackle the issue that certain distributions from offshore funds are economically similar to payments of interest. It is intended to ensure that distributions of that type are taxed as if they are payments of interest.
The issue arises because of the differential in the tax rates for UK residents and domiciled individuals between dividends, which are taxed at 32.5 per cent., and other forms of income, which are taxed at 40 per cent. Until now, offshore funds, particularly those formed as corporates, were able to pay out a dividend to UK investors that would be taxed at 32.5 per cent. That was the case even when the offshore fund was invested primarily in debt assets that in substance paid out an interest return. In contrast, UK funds are required to distinguish between dividend distributions and interest distributions, with interest distributions being taxed at 40 per cent.
Clause 39 seeks to address that disparity by introducing a bond fund test for offshore funds. Individual UK investors will be required to distinguish between distributions received from bond funds and from non-bond funds for any distributions paid on or after 22 April 2009. The bond fund test is derived from the test that UK corporates are required to apply to their investments. Broadly, an offshore fund that at any point during an accounting period has more than 60 per cent. of its assets invested in interest-bearing securities will be deemed a bond fund. The impact of that is that any decision made by a bond fund in relation to the profits of that period will be deemed an interest distribution. That will help the UK investment management industry by reducing the disparities in the taxation of distributions from onshore and offshore funds.
Budget notes 21 and 22, which underpin this measure, state that the intentions behind these changes are to enable individuals with holdings of 10 per cent. or more in non-UK resident companies to become entitled to a non-payable tax credit on dividends from such holdings, and to restore the non-payable dividend tax credit for offshore funds that are largely invested in equities, subject to certain conditions. However, as the clause is drafted, it is not clear whether the tax credit is available in respect of a distribution from an offshore fund that fails to meet a non-qualifying investments test where a distribution is made to a minority shareholder in an offshore fund with authorised share capital—that is condition A—or an offshore fund in a qualifying territory—that is condition C. Amendment 171 would make clear the application of that.
Amendment 174 addresses the problem that requirements to measure whether an offshore fund fails to meet the qualifying investments test at any time during an accounting period are over-burdensome. It is likely to prove impossible for funds to comply with those requirements in practice. It is the “at any time” point that I am trying to address with the amendment. It is quite a lengthy amendment because it would introduce new subsections (3), (3A) and (3B) to try to make the process smoother.
New section 378A will introduce to the Income Tax (Trading and Other Income) Act 2005 a tax credit for dividends paid by offshore funds. However, as I said, the tax rate is not available if the offshore fund fails the qualifying investments test at any time during the accounting period. If the test is failed, the dividend will be taxed at the income tax rates applicable to interest. As I said earlier, the offshore fund will fail the qualifying assets test if, at any time during its accounting period, the market value of the qualifying investments exceeds 60 per cent. of the market value of all its investments.
“Qualifying investments” means interest-bearing instruments and instruments such as derivatives that relate to the performance of interest-bearing investments. The definition of qualifying investment also includes interest on funds that could fail the qualifying investments test. When paying a dividend, an offshore fund will need to let its shareholders know whether the test has been failed so that it can file proper tax returns and pay the appropriate rate of tax.
An offshore fund may hold a complex, extensive and constantly changing portfolio of assets. To ensure that the qualified investment test is met at any time, the fund will have to ascertain daily the market value of each underlying asset, which is over-burdensome. For a fund of funds, such a level of monitoring would prove impossible. It will not have the information on the underlying funds.
A similar test exists in relation to offshore funds held by UK companies. In practice, that may be invoked relatively infrequently, because a UK company is not a common vehicle through which investments in offshore funds are made. Extending a test to apply to all shareholders in an offshore fund will require many more funds to operate those requirements. The amendment would impose a workable monitoring requirement that remains sufficiently rigorous to leave little or no scope for abuse.
Amendment 175 asks whether a requirement to measure whether an offshore fund fails to meet the qualifying investments test during a relevant accounting period is over-complicated. In this case, the problem stems from the definition of a relevant period of accounting, which is either the accounting period ending prior to the payment of the dividend if there are undistributed profits available to that period or, otherwise, the accounting period in which the dividend is paid. That is quite a complex definition because it will require significant record keeping on the part of the offshore fund. It may result, in relation to the second limb of the test, in a mismatch between the data on which the fund is able to inform its shareholder that the qualifying test has been met or failed, and the data on which an investor must file a tax return.
To use 2009 as an example, if a fund had a calendar-based accounting period and paid a dividend in January 2009, it will not know until some time after 31 December 2009 whether the qualifying investments test was met for the period. However, the dividend must be included in the tax return for the year ending 5 April 2009. That could give rise to a situation in which a fund is not given enough time in which to carry out its calculations and report to investors before the tax return is due.
Amendment 175 would alter the Bill so that an offshore fund could measure whether it has satisfied the qualifying investment test by reference to its investment strategy in the accounting period immediately prior to the payment of the dividend. We are trying, with the amendments, to simplify things for investors in the funds while maintaining the spirit and purpose of the clause.