Clause 135 - Offshore funds

Finance Bill – in a Public Bill Committee at 5:00 pm on 25th May 2004.

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Photo of Mr Howard Flight Mr Howard Flight Shadow Chief Secretary To the Treasury, Economic Affairs, Shadow Chief Secretary to the Treasury 5:00 pm, 25th May 2004

I beg to move amendment No. 192, in

clause 135, page 126, line 7, leave out

'the day on which this Act is passed'

and insert '17th March 2004'.

[R] Relevant registered interest declared.

Photo of Mr John McWilliam Mr John McWilliam Labour, Blaydon

With this it will be convenient to discuss the following amendments:

No. 193, in

schedule 26, page 408, line 29, leave out from beginning to 'this' in line 30.

No. 196, in

schedule 26, page 408, line 29, leave out

'the day on which this Act is passed'

and insert '31st December 2005'.

No. 194, in

schedule 26, page 409, line 20, leave out from beginning to 'this' in line 21.

No. 197, in

schedule 26, page 409, line 20, leave out

'the day on which this Act is passed'

and insert '31st December 2005'.

Again, this is quite a narrow group of amendments.

Photo of Mr Howard Flight Mr Howard Flight Shadow Chief Secretary To the Treasury, Economic Affairs, Shadow Chief Secretary to the Treasury

May I crave indulgence by saying up front that the investment management industry—and I personally declare an interest for the register—was greatly concerned that the measures under this part of the Bill would be damaging for the industry, and especially potentially damaging for hedge funds, and there is great relief that the reverse is the case. The clause contains some important relaxations, and it will enable umbrella funds to include distributing and non-distributing funds, which saves quite a lot of time, administration and costs for individual investors. The measures are essentially welcome.

There are two starred amendments in the group, but to a large extent they are a different way of achieving the aims of two of the other amendments, which deal with accounting date issues and including as large a number as possible of funds within the new arrangements. The start date in the clause is likely to exclude those funds with a 30 June 2004 year end. Amendment No. 192 suggests that the date should be brought forward. An eventuality that appears not to be covered is the position relating to a sub-fund or a share class that ceases prior to the effective date, and the implications of that in relation to whether the sub-fund falls under the new or old rules.

Amendments Nos. 193 and 194 are alternative versions, in a sense, of Nos. 196 and 197. They are a response to the fact that the change in calculation of UK equivalent profits from an income tax basis to a corporation tax basis in connection with creditor relationships and derivative contracts, as the clause stands, raises some problems that might be better dealt

with within the Bill. Following a pragmatic approach, the amendments would do away with the complication and uncertainty in calculating UK equivalent profits for bonds and derivatives as the accounting measure will tend to be followed. However, an important assumption is that the accounts of the funds are compliant with the authorised unit trust statement of recommended practice.

More guidance is required on what will be accepted by the Inland Revenue in relation to what the offshore fund managers need to do to prove the fund accounts are SORP-compliant. There have been some discussions with the Revenue on the amendments, and I repeat that there are two versions: amendments No. 193 and 194 and amendments Nos. 196 and 197. We seek to standardise accounting arrangements in the future.

Photo of Ruth Kelly Ruth Kelly Financial Secretary, HM Treasury

I will ask the Committee to reject the amendment. Before I address the specific points raised, it may help if I explain the purpose of the changes that we are proposing. Their aim is to provide more flexibility for fund managers to tailor their products to the marketplace and to enable more UK investors to use the tax rules that they would have used if they had invested in an equivalent UK fund.

The changes focus on the rules for an offshore fund to obtain distributor status. That in turn determines the tax treatment of the UK investor. There are three main changes. First, offshore funds will be able to use the same corporation tax rules as a UK unit trust in measuring their distributions against their profits instead of income tax rules. Secondly, some of the investment restrictions are abolished. Thirdly, separate sub-funds and classes of interest can qualify for distributor status individually in their own right without affecting or being affected by other parts of the fund.

The Bill provides a regulatory power to deal with some mainly administrative issues arising from applying the rules to sub-funds and classes of interest. Consultation with industry representatives is in train to identify what regulations will be needed, but at this stage I can assure the Committee that I have seen nothing to suggest that the regulations will cover anything other than minor points of detail and/or transitional issues that would overburden the primary legislation with changes with a short lifespan.

The changes follow a productive period of consultation with the funds industry. I am confident that they will be welcomed by fund managers and investors alike. Indeed, I note the support of the hon. Member for Arundel and South Downs for the overall thrust of the changes.

Amendment No. 192 seeks to bring forward the commencement date so that the changes apply to account periods ending on or after Budget day—17 March 2004—instead of on or after the date of Royal Assent. However, I draw to the Committee's attention the fact that the changes have already been announced. They have been welcomed by fund managers, who have already started planning in

response to them. They will have taken decisions based on the expected start date. If we change that to 17 March, some fund managers may have to unpick commitments that they have given, and that may not even be possible.

Moreover, if the new rules were to apply to account periods ending on or after 17 March 2004, they would affect the last but one tax year. It would be wrong to expect some investors to check back to that year to determine whether they were affected. If the start date is left as it is, it will affect only the tax year that has just ended.

The hon. Gentleman asked about a sub-fund or share class that ceases before the effective date. The new rules allow the sub-fund or class of interest to take the same account period as its umbrella fund in order to qualify under the new rules, provided that the umbrella fund account date falls after the commencement date. I imagine that that deals with the hon. Gentleman's concern.

The remaining amendments appear to address the same point, so I shall take them together. The changes respond to a long-held concern of the industry: namely, that to test for distributor status, accounts had to be recast on an income tax basis for interest income and income from derivative contracts such as futures and options. The industry pressed us to allow it to move to the full corporation tax basis, and we have changed the rules in response to its concerns. We also took note of its concerns that existing funds might need time to change their systems and deal with any transitional problems before moving fully to the new basis. The new rules allow for that to happen.

The amendments would allow wholly new funds to use the old income tax-based method to test their distributor status. That would run counter to the aim of the changes and counter to what the industry clearly wants. Both the industry and the Government wish to phase out the old rules, but we will not achieve that if yet more funds start up under them.

I note that amendments Nos. 193 and 194, which would allow new funds indefinitely to use the old rules, have been tempered by the later proposals to allow that only for new funds established on or after 31 December 2005. However, that would still allow new funds to work on the old basis long into the future; for example, a new fund established in December 2005 would draw up its first accounts in December 2006. Fund managers argued that the corporation tax basis was the way forward and, having agreed to that, we wish to press ahead without undue delay.

The hon. Gentleman asked about SORP. The Revenue is discussing with the industry how to take that forward in guidance. I will respond to him if he writes to me with particular concerns.

In summary, we have gone a long way towards achieving the reforms for which the industry has been looking. The changes will boost funds' ability to compete in the market. This is a changing environment. I welcome the positive dialogue with the industry that led to the changes, and I assure the

Committee that that dialogue will continue. I urge the hon. Gentleman to withdraw his amendments.

Photo of Mr Howard Flight Mr Howard Flight Shadow Chief Secretary To the Treasury, Economic Affairs, Shadow Chief Secretary to the Treasury

Amendment No. 192 is intended simply to allow more funds to take advantage of the new flexibility earlier. It is a minor, constructive point, and I take the point that the main concern has been addressed.

The two other sets of amendments are supported by the industry and the Institute of Management Accountants, which I understand are in continuing discussions with the Inland Revenue. The issue is that the Bill prescribes one regime for accounting standards for funds established before Royal Assent, and another for funds established afterwards. Funds subject to other jurisdictions' accounting requirements have to perform additional computations of UK equivalent profits, and that has given rise to a lot of operational hassle. The Bill proposes that funds established on or before Royal Assent can elect to compute UKEPs arising from creditor relationships and/or derivative contracts by reference to chapter 2 of part 4 of the Finance Act 1996 and schedule 26 of the Finance Act 2002 as if they were an authorised unit trust. However, the same flexibility is not provided for funds established post-Royal Assent.

The amendments would provide that flexibility for funds established post-Royal Assent but before international accounting standards were adopted in January 2006, and from January 2006 the Government would use the new regulatory power to update the reference to international accounting standards. In its discussions with the Revenue on that point, the IMA had been seeking to implement a common implementation date, and it hoped that that would have support.

Photo of Ruth Kelly Ruth Kelly Financial Secretary, HM Treasury

I thought that I had dealt with the hon. Gentleman's amendments during my response to his concerns. The issue of international accounting standards applies to listed companies and consolidated accounts for the accounting period starting on or after 1 January 2005. In the United Kingdom, individual companies may use them from that date too, but other jurisdictions may have other rules or requirements and are unlikely to be driven by when the offshore funds themselves will be required to adopt international accounting standards. We are in continuing discussions with the industry about how the issue will be dealt with, and I am sure that we will be able to respond to the point to the satisfaction of both parties. On that basis, I hope that the hon. Gentleman will seek leave to withdraw the amendment.

Photo of Mr Howard Flight Mr Howard Flight Shadow Chief Secretary To the Treasury, Economic Affairs, Shadow Chief Secretary to the Treasury

In respect of amendments Nos. 196 and 197, I understood that there was some agreement between the Revenue and the IMA on the arrangements. On the basis of what the Minister has said, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 135 ordered to stand part of the Bill.