Grant Thornton decided to undertake an industry survey and produce a summary document, designed to facilitate discussions of the issues faced in complying with the new Reporting Fund (RF) regime. This survey is designed and intended for individuals responsible for UK tax and compliance of offshore funds marketed to UK investors.
2. Contents
The research was conducted through a
combination of telephone interviews and
an on-line survey.
Respondent anonymity has been
maintained to ensure that no comments,
views or dates can be attributed to an
individual or organisation.
This full report will be received by all
those asked to participate in the survey.
This will enable them to compare their
own responses with those of other funds,
managers and organisations.
Contents
2 Contents
3 Introduction
4 Background
5 Summary of survey findings
The Survey
6-11 Observations
12 Practical issues – Applications
13-19 Practical issues – Reporting
20-23 Summary thoughts
24 Financial Services Tax/Contacts
2 Offshore Funds Survey
3. Introduction
Intended audience income profits, albeit that losses remain The comments that we received
This survey is designed and intended as capital losses. confirmed that these issues which our
for individuals responsible for UK clients face are also concerns for the wider
tax and compliance of offshore funds Implementation offshore fund industry. The remainder of
marketed to UK investors. A level of As with any new and complex regime, this document details the responses to the
knowledge of the existing and previous and as confirmed by the results of this questions we asked and also allows for a
tax rules relating to offshore funds is survey, teething problems along the number of conclusions to be drawn.
assumed, but where specific or detailed way cannot be avoided. The original RF We would like to thank all participants
technical points are referred to further regulations and accompanying guidance who took part in this survey, without
explanation is provided. were released after a two year long whose input this survey would not have
consultation, and have subsequently been been possible.
The new regime updated four times, the most significant We hope you find this survey of
The new Reporting Fund (RF) regime of which was less than a year ago in May interest and would be pleased to discuss
came into effect on 1 December 2009. It 2011. It seems likely that this will not be further with interested parties.
replaces and is intended to simplify the the last as more funds seek to join the
previous UK Distributor Status (UKDS) new regime and raise new questions on Grant Thornton UK LLP
rules applicable to offshore funds. issues that have not been addressed in the Financial Services Tax Team
The purpose of the new regime from existing legislation or guidance. June 2012
a tax perspective remains as before, i.e. The transitional provisions within the
to prevent conversion of income into regulations allowed for distributing funds
capital gains by the rolling up of income to delay entry into the new regime for
offshore in a low tax environment and one further accounting period following
then realising this in capital form. the accounting period containing 1
With the current differential between December 2009. Other funds, particularly
the UK capital gains and income tax rates, those which in the past have had to
this is one of the ways HM Revenue & operate reinvestment mechanics or which
Customs (HMRC) seeks to prevent the had holdings in other offshore funds,
avoidance of tax by UK taxpayers. welcomed the ability to enter into the
Funds which choose to be part of regime at an earlier stage.
the RF regime are required to notify With this in mind, and with the
investors of income, as calculated under first annual reporting cycle now either
the regulations, for an accounting period. complete or currently in progress,
UK taxpaying investors must then report Grant Thornton decided to undertake
and pay tax on their share of this income an industry survey and produce a
regardless of actual distributions received. summary document, designed to
Actual distributions are not subject to facilitate discussions of the issues faced in
further tax to the extent they do not complying with the new rules.
exceed reported income allocations. The questions asked in this survey
Investors realising investments in cover a range of specific areas and
reporting funds may treat any gains tried to focus on the issues where we
arising on disposal as capital for tax know a number of our clients and the
purposes. Profits made on the disposal of wider industry have had comments and
non-reporting offshore funds are taxed as concerns.
Offshore Funds Survey 3
4. Background
A total of 50 selected A wide spectrum of asset classes is It was initially estimated that the
represented by the survey participants. survey conversation would take 20
offshore fund providers Some respondents represent small funds, minutes, but it was found that in a
and administrators were some are very large, multi-fund managers number of cases people preferred to
contacted to participate in and some are from the middle ground. complete the survey electronically.
In addition, a number of offshore fund Where conversations did take place the
this survey. administrators were contacted to gather discussion took nearer three quarters of
their views. an hour, with the longest lasting an hour
Each participant was informed of the and a half. This is clearly indicative of the
objectives of the research survey and richness of the responses and the extent
the survey questionnaire. The survey of the consideration given to compliance
questionnaire contained 23 specific with the regime. The time commitment
questions which were grouped under from all involved in this process is very
four headings: much appreciated.
Discussions took place with Chief
• Observations Financial Officers, Chief Operating
• Practical issues – Applications Officers, Product Managers and others
• Practical issues – Reporting closely involved in the offshore funds
• Summary thoughts regime. Respondents were forthcoming
and candid in their views expressed.
Selected anonymised comments are used
throughout this document to emphasise
a point or to support conclusions reached
by Grant Thornton.
4 Offshore Funds Survey
5. Summary of survey findings
The original aim of the Simplification In line with expectations, 62%
Perhaps unsurprisingly, only 22% of of respondents are using a website
regulations was to remove respondents think that the new RF as a means of reporting to investors.
impediments from the regime is simpler than the previous However, there is concern that
UK tax regime for multi- UKDS regime. That said, for the information is not reaching the
majority of people we have spoken to underlying investor, especially where
tiered fund structures, by who have now completed their first year nominee accounts are used or where
simplifying the operation of reporting, the process appears to have investors do not have access to the
of the offshore funds tax run smoothly. internet.
regime and providing more
Income distribution Equalisation
certainty to UK investors When asked whether or not having to Although only 23% of respondents
and funds. Although the distribute income has influenced the have had difficulties with the operation
removal of the 5% test decision to join the regime, only 41% of equalisation, most respondents
of respondents felt that it had. However, highlighted equalisation as being an
for investment in other of those that felt that it had not, a added complexity for which they
non-qualifying offshore number acknowledged the ability now would like to see further guidance from
funds goes a long way to for accumulation funds to apply for RF HMRC. Surprisingly, given the last man
status as being a welcome development, standing issue, only 22% of respondents
achieving this aim, it is potentially enabling some hedge fund have changed their approach to
questionable whether the promoters to now market to the UK equalisation.
requirements of the RF without adverse UK tax consequences
for investors.
regime are simpler than
those of the UKDS rules. Administration costs
52% of respondents have seen
administration costs increase, with the
operation of equalisation and increased
reporting duties being the main reason
behind these increases.
Reporting
The majority, 70%, of respondents
would like to see a pro-forma template
introduced to allow a standardised
form for reporting. It is believed
that this would provide consistency
amongst reports helping to improve
investor understanding. Worryingly,
but perhaps unsurprisingly, only 19%
of respondents feel that investors have a
good understanding of the information
they are provided with.
Offshore Funds Survey 5
6. Observations
Q. The new definition of an offshore fund Fig 1: New definition of an offshore fund
has resulted in many more funds coming
within the new regime. Do you have funds
Yes
which fell outside the old definition but 17%
now come within the new definition of
an offshore fund, and if so, how has this
impacted your business?
Not applicable
83%
Grant Thornton comment:
A new tax definition of an offshore fund came into effect on 0 20 40 60 80 100
1 December 2009, potentially resulting in more funds coming
into the regime for the first time and therefore having to
consider the impact of the regulations.
Most respondents (83%) felt that this had little impact on
their business.
The new definition of an offshore fund provides a new
characteristics driven definition of a ‘mutual fund’ (S.355
& S.356 TIOPA 2010). In the run up to the introduction of
the new rules it had perhaps been anticipated that a number
of funds previously excluded from the old definition of
an offshore fund would be caught by the new rules. The
response to the question indicates that this is not necessarily
the case.
As an aside (although untested by this survey) it would
“We now have to prepare RF
perhaps be interesting to assess how many funds and calculations for funds that
managers outside of the old UKDS regime have undertaken
a review to assess the applicability of the RF regime across previously did not require it”
their full range of products.
For those answering positively, the inclusion now of some
closed ended funds has created additional work.
6 Offshore Funds Survey
7. Q. The new RF regime facilitates funds not Fig 2: Income distribution
having to distribute their income. Has this
influenced your decision for funds to join
Yes
the new regime? 41%
Grant Thornton comment:
The new rules makes RF status more accessible to funds which No
had previously been unable or unwilling to satisfy the UKDS 59%
requirements.
A significant number of respondents considered the
introduction of the new rules as a reason to bring in funds 0 10 20 30 40 50 60
which had previously been excluded.
This is supported by what is known about the wider
market. Since the inception of the new regime HMRC’s data
shows that there has been an approximate 60% increase in the
number of reporting funds registered compared to the number
of funds registered for UKDS. A number of funds have taken
the opportunity to launch new share classes while the removal
of the 5% test has allowed more fund of fund structures to
enter the regime.
In terms of respondents answering no to this question, a
number cited the potential for ‘dry tax charges’ (investors
being assessed to tax on a reported income figure and not
having the associated distribution to pay the tax) as a reason
for not bringing more products within the scope of the new
“Clients are taking the
rules.
The point made by respondents is very valid where
opportunity not to distribute
investment strategy gives rise to significant income streams.
However, where capital growth is the main investment
as a way of entering the
driver, with only minimal income arising, it seems likely that
funds in this position will have chosen to accept a degree of
regime, and are now
administrative work in return for the perceived benefit RF
status brings. This perhaps indicates one of the reasons why
marketing heavily in the UK”
the take up of the new regime has been so high.
Offshore Funds Survey 7
8. Observations
Fig 3: Retrospective UK Distributor Status applications
Q. Where you have funds that have now
decided to join the RF regime but did not
previously have UKDS, despite being
classified as offshore funds, have you
considered retrospective applications for
UKDS to potentially help mitigate tax
Yes
32%
liabilities of UK investors?
Not applicable
39%
Grant Thornton comment:
HMRC has, in the past, allowed retrospective applications for
UKDS by funds which have not previously been distributing.
This is often seen where funds have little or no income and the
extra administration of being part of the regime going forwards
No
29% was seen as an acceptable trade-off for the associated investor’s
tax benefits. As many readers will be aware, without a specific
election by an investor, a fund must have held UKDS or have
been part of the RF regime for an investor’s entire period of
ownership in order to ensure capital treatment on disposal.
With the introduction of the RF regime it had been
anticipated that some funds would join the regime and bring
older periods into UKDS by making retrospective applications.
One particular respondent to the survey confirmed that their
organisation has made a number of retrospective applications for
long only, non-trading hedge funds.
The results support this hypothesis in that 32% of survey
respondents have considered making retrospective applications.
8 Offshore Funds Survey
9. Fig 4: Applications for new products
50
40 Not applicable
41%
No
30 35%
Yes
20 24%
10
0
Q. Has the new regime facilitated making RF
applications for products which you were
previously unable to obtain UKDS for, and
if so, what types of products?
Grant Thornton comment:
The RF regime has opened up the opportunity for funds and
products to enter into the regime where before they were
unable to do so due to restrictions imposed under the old “We now have in excess
regulations.
The removal of the requirement to distribute and the of 500 share classes
5% investment restriction are welcome developments, and
has led to both accumulation shares and some hedge funds registered as reporting
now joining the regime. There has also been a significant
increase in the number of fund of fund structures joining the funds”
regime, although a number of respondents have experienced
difficulties in collating the necessary information from
underlying funds.
Offshore Funds Survey 9
10. Observations
Fig 5: Marketing assistance
60
No
59%
50
40
30
Not applicable
20 24%
Yes
17%
10
0
Q. To assist with marketing, have you
applied for RF status for funds which
strictly do not need the status, for example,
transparent funds?
Grant Thornton comment:
Certain fund types, for example some foreign unit trusts
and Fonds Commun de Placement, are tax transparent for
income purposes but opaque for capital gains purposes, and
are therefore within the new definition of an offshore fund.
However, even if the fund chooses to be a non-reporting fund,
it is possible for it to still be excluded from potential offshore
income gains treatment provided they meet certain conditions.
As such, there may be no advantage to these funds being in the
regime, although some providers have nevertheless sought to
apply for RF status in respect of these funds. “We have applied for good
non-reporting status for a
Comments from some respondents indicate that the
marketability of new products is improved if membership of
number of funds”
the RF regime can be shown even if it is perhaps not needed.
This could well be driven by less sophisticated investors or
those with strict investment due diligence checklists.
10 Offshore Funds Survey
11. Fig 6: Administration costs Q. Have you seen administration costs
60 increase as a result of complying with the
new regime?
50 Yes
52%
40
No Grant Thornton comment:
38%
30 Owing to the increased requirements to provide information
to both HMRC and investors it was anticipated that
20 administrative costs would increase under the new regime.
Comments from respondents indicate that the RF regime
10 Not applicable is seen as significantly more complex than UKDS. Specific
10%
0 areas mentioned which have added complexity and therefore
costs are effective yield calculations, collation of information
for fund of funds and equalisation.
In addition the number of non-UKDS funds which have
now joined the RF regime will have increased overall costs
for larger managers and administrators with wide portfolios
of products.
Offshore Funds Survey 11
12. Practical issues - Applications
Fig 7: Application rejected Fig 8: Further information
Yes
Yes 14%
0%
Not applicable No
100% 86%
0 20 40 60 80 100 0 20 40 60 80 100
Q. If you have had an initial RF application Q. Have you been asked by HMRC for
rejected, what were the stated reasons and further information for either the initial
the ultimate outcome? application or the subsequent reports, and if
so, what further information was required?
Grant Thornton comment:
Managers of offshore funds are now able to obtain forward
looking certification of a fund as a reporting fund which
will continue to apply until the fund chooses to leave or is
removed from the regime.
“More information required Respondents commented that HMRC has requested
further information to asses initial applications in limited
on derivatives and series circumstances, these being where derivatives were being used
share classes”
and series of share classes being operated. However, in our
sample no legitimate applications had actually been refused
by HMRC.
12 Offshore Funds Survey
13. Practical issues - Reporting
Fig 9: Reportable income calculations and reports Fig 10: Pro-forma template
Yes
70%
Yes
81%
No
22%
No
19%
Not sure
8%
0 20 40 60 80 100 0 10 20 30 40 50 60 70 80
Q. Have reportable income calculations and Q. Would you like to see a pro-forma
reports for investors now been prepared for template to allow a standardised form for
your funds? reporting?
Grant Thornton comment: Grant Thornton comment:
The new rules came into effect on 1 December 2009, meaning The issue of a standardised form of reporting has been
that the majority of funds have now prepared, or are in the raised with HMRC, who has stated that it has no objection
process of preparing their first reportable income calculations. in principle. However, HMRC is also wary of being too
However, there are still some funds that were already prescriptive and suggest that an industry-led tool solution
certified under the UKDS regime which have elected to would seem appropriate.
use the transitional provisions to continue to be certified as Respondents to the survey were very much in favour of
distributing funds for as long as possible. The reason cited for standardised reporting, however the complexity and variety
delaying entry into the new regime is the perception that the of offshore funds would require an extremely sophisticated
UKDS regime is simpler. The requirement to report 100% of ‘one size fits all’ type reporting programme. Respondents
income rather than 85% has also been a factor. acknowledged this, and a number stated that although they
liked the idea in principle, they could see how in practice this
would not be easy to implement.
“Difficult to implement with different options for equalisation”
Offshore Funds Survey 13
14. Practical issues - Reporting
Fig 11: Format of report
Q. In what format are you making your
report to investors available?
Other Grant Thornton comment:
7%
Reporting funds are required to make a report available
Individual email
to investor to each investor who is resident in the UK (or which is a
12%
reporting fund) within six months of the end of the reporting
period.
Clearly, the majority of respondents favour the
Individual letter dissemination of information via the internet given
to investor
19% the saving in cost and administration this represents.
Website
62% Smaller organisations may tend to use a variety of other
communication methods suited to the needs of their
investors.
Whilst the internet was clearly the method of choice for
the majority of those we spoke to, a number of respondents
expressed concern as to whether the relevant information was
ending up in the hands of the underlying investor, especially
where nominee accounts were being operated.
Although HMRC is sympathetic to the industry’s
concerns, it has expressed the view that to the extent that the
fund is aware that the method of delivery does not achieve
the required outcome, then it is the fund’s responsibility to
consider whether the information should be supplied in a
different format.
“My concern is what
happens to those without
internet access”
14 Offshore Funds Survey
15. Q. Do you feel that investors have a good
Fig 12: Investor understanding
understanding of what the information
50 Not sure means and what they are required to do
50%
with it?
40
30 No
31% Grant Thornton comment:
20 Reports to investors must inform investors of the amount
Yes actually distributed, the excess of the amount of the
19%
10 reportable income over the amount actually distributed, and
where applicable, the amount of equalisation per unit. There
is concern that non-professional investors will not fully
0
understand the implications of the reports.
Clearly, the fact that only 19% of respondents felt that
their investors actually understood the information that they
were being provided with, suggests that managers could
potentially be doing more to educate their investors on what
the information means.
Funds who tried to address this at the outset, by
educating their professional intermediaries as to the
implication of the new rules, now feel that this has been
particularly beneficial. However, there is still an overriding
concern that there is a gap between the sophisticated and less
sophisticated investor.
Offshore Funds Survey 15
16. Practical issues - Reporting
Fig 13: Equalisation
No equalisation
31%
Equalisation
“I don’t believe you should
19%
be allowed to operate
Full equalisation
27%
without equalisation. It
should be mandatory”
Income adjustments on basis of reported
income 4%
Income adjustments on basis of accounting
income 0%
Different funds using
different methods 19%
0 5 10 15 20 25 30 35
Q. Are you operating equalisation, and if so,
what method?
16 Offshore Funds Survey
17. “Addressing the ‘last man
standing’ issue”
Fig 14: Equalisation difficulties Fig 15: Approach to equalisation
Yes
23%
Yes
22%
No
46%
No
Not applicable 78%
31%
0 10 20 30 40 50 0 10 20 30 40 50 60 70 80
Q. Are you aware of any difficulties that Q. Have you changed your approach to
have arisen in the operation of equalisation equalisation since the introduction of the
or in doing the income adjustments? RF regime, and if so, why?
Grant Thornton comment:
The new regulations give a fund five options regarding the
operation of equalisation. The results show that there does
not appear to be one preferred method, with different funds
choosing different methods.
“A practical / pragmatic The overriding reason behind these different methods being
solution was agreed with
adopted was the fact that some funds are operationally able
to operate equalisation while others are not currently able
HMRC”
to do so. Our observation of responses indicates that certain
jurisdictions are more accustomed to operating equalisation
than others, and have been doing so for a number of years.
A number of funds and administrators have encountered
various issues ranging from operational difficulties to problems
with accounting under overseas GAAPs. Hedge funds also
have to deal with performance fee equalisation to add to the
complexities.
Although not necessarily reflected in the results, in
our experience the need to address the ‘last man standing’
issue has led to more income generating funds operating
equalisation under the new RF regime. In addition, improved
administration systems now allow equalisation to be operated
where it wasn’t before due to operational constraints.
Offshore Funds Survey 17
18. Practical issues - Reporting
Fig 16: Split between share classes Fig 17: Reportable income from offshore funds
100 50
Not applicable
48%
80 No 40
85%
No
60 30 36%
40 20
Yes
Not sure 16%
20 Yes 11% 10
4%
0 0
Q. Have your funds had any difficulties Q. If your funds have holdings in other
obtaining underlying information relating to offshore funds, have they experienced any
the split of income/expenses between share issues obtaining the reportable income
classes? If so, please explain how you overcame figures from those funds?
these difficulties.
Grant Thornton comment: Grant Thornton comment:
Each share class of an offshore fund is now considered to be an The abolishing of the investment restriction under the
offshore fund in its own right. Although most administrators are previous regime has made it easier for funds of funds to
now able to provide a split of income and expenses across the achieve certification as reporting funds. However, there is
different share classes there are still instances where funds are the additional administrative complexity of determining
having difficulties obtaining the relevant information. In these the relevant income to be recorded where funds of funds
instances, HMRC has stated that it is likely to have no issue in are invested in a wide variety of reporting and non-
the income/expenses being allocated across the share class based reporting funds.
on the Net Asset Value of the share classes, as long as it produces
a reasonable outcome.
18 Offshore Funds Survey
19. Fig 18: Series accounting
Yes
4%
“Only problem is series
accounting costs more” No
15%
Not applicable
81%
0 20 40 60 80 100
Q. Where share classes operate various
series, is reporting in these instances a
problem in practice? What problems do
you face in this area?
Grant Thornton comment:
A large number of funds, particularly in the hedge fund
industry, issue units in series. Historically, series tended
not to be an issue under the UKDS regime, but with the
increase in hedge funds in the RF regime there has been
concern about the potential for increased administrative
complexity if each series is treated as a separate fund, as is
strictly required.
HMRC has confirmed that where series are collapsed
into one share class at the end of a reporting period only
one figure of reportable income is required for that share
class, thereby reducing the burden on funds. In other cases,
however, separate calculations are currently still required.
The high level of not applicable responses probably
reflects the fact that although common for hedge funds,
series accounting is not so common with the total
population of funds.
Offshore Funds Survey 19
20. Summary thoughts
Q. Do you believe that the new RF regime is
Fig 19: Complexity of regime
more or less complicated than the old UKDS
Less
regime, and can you give reasons why?
22%
More
Grant Thornton comment:
33% The new regime came into effect on 1 December 2009, and as
such the industry is still getting used to the regime. Teething
problems are inevitable, but it is hoped that with time the
Not sure new regime will be a favourable improvement, removing
45% some of the restrictions imposed under the previous regime
and providing more certainty to investors.
0 10 20 30 40 50 The one clear issue that people do have is with the
operation of equalisation, and the complexities that it brings.
“The rules are simply more
complicated, especially on
equalisation”
20 Offshore Funds Survey
21. Fig 20: HMRC guidance Fig 21: Other jurisdictions
40 80
35 Yes No 70
37% 37% No
30 60 69%
25 Not sure 50
26%
20 40
15 30
Not applicable
10 20 27%
Yes
5 10 4%
0 0
Q. Is the HMRC guidance detailed enough? Q. How do the RF rules compare to other
What other areas would you like to see jurisdictions where you have to report, for
covered in the guidance? example Germany? Are the UK’s rules more
complex?
Grant Thornton comment: Grant Thornton comment:
The original guidance has recently been updated to As can be seen from the opinions expressed in Figure 21,
incorporate the amending regulations that came into place the resounding indicative belief is that the UK’s RF regime
on 27 May 2011. Whilst the guidance is useful in a number of is far less complex than that of Germany, as well as Italy,
areas it is still felt that more detail could be given in certain Austria and the US. However, it was also not considered
areas, especially regarding equalisation and the adjustments to be the most straightforward, especially under the new
required to arrive at reportable income. regulations.
HMRC has acknowledged that further updating will be
required. It is early days under the new regime and practical
problems are still arising that will lead to further guidance
being published. In the interim, HMRC has indicated that it
plans to maintain a Q&A page for issues not covered in the
current guidance.
Offshore Funds Survey 21
22. Summary thoughts
Fig 22: Standardised approach across Europe Fig 23: Exclude certain funds
Yes Yes
52% 27%
No No
30% 12%
Not sure Not sure
18% 61%
0 10 20 30 40 50 60 0 10 20 30 40 50 60 70 80
Q. Do you believe a standardised approach Q. Do you believe the definition of an
to investor reporting across Europe should offshore fund should be amended to exclude
be pursued? If yes, do you have any certain funds which are required by their
thoughts on how this could be achieved? home regulator to distribute all income, for
example, certain US funds?
Grant Thornton comment: Grant Thornton comment:
Although half the respondents believe that it is a good idea Certain funds are required by regulation to distribute all their
to standardise reporting across Europe, most doubted that income to investors, eliminating any risk of them rolling up
it could be practically implemented unless fiscal unity is income offshore. For these funds, complying with the UK’s
achieved. offshore fund rules is an administrative and costly burden
that adds no real value to the fund or to HMRC.
22 Offshore Funds Survey
23. “The investment industry across the whole EC should
have its own reporting standard relevant to Collective
Investment Schemes”
Offshore Funds Survey 23