Offshore funds with 31 December accounting dates and their investment managers should take note of the approaching deadline for filing applications to achieve reporting fund status for UK tax purposes.

Background

The offshore funds rules seek to tax certain gains of UK investors in offshore funds as income. Under the new regime, if an offshore fund qualifies as a “reporting fund” during the entire period of ownership by an investor, any gains arising on that investor’s disposal of his interest remain subject to tax as capital gains. The availability of capital gains tax treatment is particularly relevant now that the capital gains tax rate for individuals is 18% in contrast to the planned increase in the highest marginal rate of income tax to 50% (from 6 April 2010).

In order to qualify as a “reporting fund”, a fund must make an application to HM Revenue & Customs (“HMRC”) (see below). It must then report 100% of its income to shareholders, and shareholders who are resident or ordinarily resident in the UK for tax purposes will be taxable on such reported income whether or not the income is actually distributed. The fund must make a report available to UK investors within six months of the end of the relevant period.

Applications

In order to qualify as a reporting fund, a fund must apply to HMRC within three months of the start of the first accounting period for which the fund wishes to be a reporting fund. This means offshore funds with a 31 December accounting date must apply to HMRC by 31 March 2010 if they wish to be certified as a reporting fund for the accounting period ending 31 December 2010.

Special rules apply to new funds and existing funds not previously made available to UK investors. In the case of new funds, the three-month deadline runs from the first day on which interests in the fund are first issued to participants. In the case of existing funds not previously made available to UK investors, the three-month deadline runs from the first day on which interests in the fund are made available to investors resident in the UK.

White List Exemption for UCITS and Certain Other Funds

Certain offshore funds that achieve reporting fund status may also benefit from the ‘white list’ exemption that gives certainty that qualifying transactions will not be treated as trading in nature for the purposes of the reporting fund rules. The profits made from such transactions will then not count towards the fund’s reportable income. Only a limited range of regulated offshore funds, in particular UCITS, can benefit from this exemption.

In order to benefit from the white list, qualifying funds must satisfy certain conditions. One of the conditions, the “genuine diversity of ownership” condition, requires the fund documentation to include certain statements regarding the intended availability and marketing of the fund and its intended categories of investor.

It is possible for the manager of a qualifying fund to seek clearance from HMRC that the white list exemption will apply. It is recommended that qualifying funds ensure the fund documentation contains the required wording and that they apply for white list clearance at the same time as seeking certification as a reporting fund.