HMRC has recently published draft regulations to amend the newly revised UK offshore funds tax regime. A key proposed change is confirmation that the disposal by a private equity fund of SPVs established to hold unlisted trading companies will not give rise to an offshore income gain under the offshore fund rules. The draft regulations also address equalisation arrangements.

The draft new exception from an offshore income gain arising under the offshore fund rules will apply to a disposal of an interest in a non-UK company (the SPV) provided that at least 90% of the value of the assets of the SPV are holdings in unlisted trading companies:

  • throughout the period during which the SPV is held; and
  • at the time of disposal of the SPV.

Such a disposal could, under the rules as they currently stand, trigger an offshore income gain under the revised regime introduced from 1st December 2009 (making any gain subject to income tax and not capital gains tax). This has been potentially a big issue for UK individual investors in tax transparent funds (such as LPs) including individual holders of carried interests. The issue arose because, for UK tax purposes, investors are treated as holding interests in the offshore SPVs established by the private equity fund and because most private equity funds have a determinable life, the SPVs may also be considered to have a determinable life and therefore within the scope of the offshore fund rules. This is problematic where a disposal of the underlying investment is made by the SPV and then the SPV distributes the sale proceeds to the fund for distribution to investors.

This new exception is welcome and it is good news that the Government has listened to private equity industry concerns. However, the current drafting of the exception is somewhat restricted and does not address every potential scenario that may arise. For example, the basic 90% holding requirement throughout the period of ownership of the SPV could lead to a situation where the exception would not be available if the SPV part-disposed of its unlisted holdings and held the proceeds for a period pending distribution to the private equity fund or if the SPV somehow had a significant cash holding. The draft regulations are the subject of a consultation so further changes may me made.

A link to the draft regulations can be found here (the relevant provision is Regulation 27).