(3) For the purposes of this section and subject to subsections (3A) and (3B) below, an offshore fund satisfies the qualifying investments test if, on the last day of each quarter of the offshore funds relevant period of account, the market value of the funds qualifying investments does not exceed 60% of the market value of all of the assets of the fund (excluding cash awaiting investment).
(3A) The offshore fund shall not satisfy the qualifying investments test if it makes any arrangements with regard to its investments where the purpose of such arrangements is wholly or mainly to satisfy the qualifying investments test on such relevant quarter date and where, having regard to the offshore funds overall investment strategy, the offshore fund would have been unlikely to satisfy the qualifying investments test had the test been applied on any other date.
(3B) Where any of the investments held by the offshore fund are qualifying holdings (as defined in section 495 of the CTA 2009), such qualifying holding shall not constitute a qualifying investment if the company, scheme or fund which might otherwise constitute the qualifying holding has, for the 12 month period preceding the date that the dividend is paid, provided written confirmation on a quarterly basis to the offshore fund that its investment strategy is to invest in assets which the company, scheme or fund anticipates will meet the qualifying investments test and it is not aware that this strategy has been breached..
Amendment 175, in clause 39, page 19, line 23, leave out from means to end of line 31 and insert
the accounting period ending prior to payment of the dividend..
Government amendment 89.
Amendment 172, in schedule 19, page 200, line 28, after (6), insert , section 378A.
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 capitalthat is condition Aor an offshore fund in a qualifying territorythat 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.
Briefly, by way of background, during the process of extending the dividend tax credit to portfolio investments last year, it became apparent that some funds were seeking to exploit the measure by locating their cash or bond fund ranges offshore to gain a tax advantage for their UK investors. The Government amended last years Bill to prevent investors in offshore funds from receiving the dividend tax credit and said that we would continue to examine the issue in the context of reform of personal dividend taxation and modernisation of the offshore funds regime.
Following further work, the Government are making further changes to the treatment of distributions from offshore funds as part of the personal dividends tax reform package. Clause 39 addresses distributions made by offshore funds when more than 60 per cent. is invested in interest-bearing assets. Distributed income from such funds will be taxed at the same rate as income from interest-bearing assets held directly, and income from interest-bearing assets held through a UK fund.
I will respond to the group of amendments to which the hon. Gentleman spoke in a few moments. Government amendment 89 has been tabled to ensure that clause 39 operates as intended. That does not represent a change in Government policy. However, after the Bill was published last month, technical questions were raised about whether the clause fully achieved its purpose.
Amendment 89 is to ensure that dividends received from an offshore fund that holds more than 60 per cent. of its assets in interest-bearing assets, are taxed as interests and not as dividends which would be eligible for the dividend tax credit. Specifically, doubt was raised as to whether the charged tax as interest took priority over the charged tax as a dividend, and whether the tax credit had been disapplied. The amendment puts the matter beyond doubt. It introduces a technical, consequential subsection to a section that determines the priority of various taxing provisions, and ensures that the clause operates as intended.
We recognise that the amendments tabled by the hon. Gentleman seek to address potential ambiguities in the current text of the clause. In relation to amendment 171, the Government agree that the dividend tax credit should not be available to income from offshore funds that are mainly invested in interest-bearing assets. In practice, however, the Government believe that the amendment required is a little broader, ensuring that the treatment of dividends paid by the funds as interest for tax purposes must displace any treatment as a dividend that would otherwise apply. That is achieved by the Governments amendment, as I have explained.
I also welcome the hon. Gentlemans attempt to clarify the legislation in schedule 19, with the signposting suggested in amendment 172. However, that amendment is unnecessary, we believe, because Government amendment 89 should provide the clarity that it seeks to effect.
Amendment 174 seeks to dilute the test for offshore funds not being treated as paying interest to UK investors. However, the amendment would mean that the test, in relation to qualifying investments for investors liable to income tax, would be out of line with the test applying to corporate investors in both offshore and onshore funds. That would add to complexity, rather than reduce it. The Government are willing to consider changes that would be beneficial, but any change must be consistent and we do not believe that that change is. We would be happy to receive representations on how the test could be further improved, provided that the improvements would apply the principles equally to individual and corporate holders, as well as onshore and offshore holdings. Those that follow these deliberations closely will, I am sure, want to make representations to us on the matter.
Although amendment 175 attempts to simplify subsection (5), we do not believe that it works. If accepted, the amendment would mean that an interim dividend paid out of current period income would have to be related to an earlier period of account even though the income distributed arose in the current period. That makes the targeting of the legislation ineffective.
With regard to amendment 174, the hon. Gentleman raised a point about the any time requirement, saying that it was too strict. The requirement is built in to ensure that funds cannot spend some or most of the relevant period invested in interest-bearing assets, and then exploit the rules for their investors by switching their investments. It is closely modelled on the existing test applying to corporate investors in a fund, whether onshore or offshore, so we do not believe that it will present any difficulty.
The hon. Gentleman raised the point that a fund would not know until after 31 December 2009 whether it applied, but that the information would need to be in the tax return and there was not enough time to check. Tax returns for individuals for the tax year 2009-10 do not have to be submitted until 31 January 2011, if they are sent online, so there is sufficient time for investors to get the right amount on their tax returns.
The hon. Gentleman suggested that the test for onshore might be unworkable. The onshore test is slightly different, but it does have an at any time provision, which we believe will work well. Funds generally value their investments on a regular basis, so that investors know the value of their investments. Therefore, I do not believe that there is any additional significant administrative burden as a result of the measures that we are introducing.
The Minister makes an important point about the regular valuation of funds. Clearly, any investor wishing to sell their holding in a fund would look for a valuation at the point of sale. Let us say that a fund is valued on a weekly basis for the purpose of enabling investors to sell their holding or to acquire further units in a fund. So long as it was measured at the point at which there was a valuation, would that be sufficiently often to cover the at any time basis? There may be funds that are valued on a daily basis, a weekly basis or a monthly basis. I imagine that so long as the fund was in compliance at the date at which it did its valuation for normal commercial practice, that would satisfy the at any time point.
My understanding is that that is indeed the case. However, if I have any further information, I will be happy to supply it. I hope that I have explained why the hon. Gentlemans amendments, although well intentioned, are not required. I am happy to confirm that the answer to his question is yes, so my officials advise me, unless evidence showed that that did not reflect the truth. I therefore urge the hon. Gentleman to withdraw the amendment.
That was a helpful explanation from the Minister about the flaws in the drafting of my amendments. It is important that there is consistency between corporate and personal investors where possible and between on and offshore funds. He has reassured me that the at any time issue, which came out quite strongly in the representations that we received, is not insurmountable so long as valuations take place on a regular basis, and clearly investors will drive the frequency of valuation for their own purposes. With those reassurances, I beg to ask leave to withdraw the amendment.
Amendment made:89, in clause 39, page 19, line 43, at end insert
(3A) Accordingly, in section 367 of ITTOIA 2005 (priority between Chapters within Part 4), in subsection (3)
(a) in paragraph (a), after dividends) insert , 378A (offshore fund distributions), and
(b) in paragraph (b), insert at the end or Chapter 4 (or both)..(Ian Pearson.)