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What are Offshore / Mutual Funds?
The definition of an ‘offshore fund’ is limited to ‘mutual funds’ so in effect they are the same for UK resident investors where the funds are based in a territory outside the UK. The statutory definition of the term ‘mutual fund’ is provided by TIOPA 2010, s356.
Broadly, the mutual fund definition applies to a company (s 355(1)(a)), a trust (s 355(1)(b)) or any other vehicle or arrangement (s 355(1)(c)) that has the following characteristics:
- it is not UK tax-resident;
- it exists to enable participants to take part in the benefits arising from the acquisition, holding, managing, or disposing of assets of any description;
- the participants do not have day-to-day control of the management of the property, whether or not they have the right to be consulted or give directions; and
- a ‘reasonable investor’ would expect to be able to realise any investment based entirely or almost entirely by reference to the NAV of the assets under management or, alternatively, by reference to an index of any description.
The legislation is drawn widely and encompasses any arrangements with respect to property of any description, including money, so it does not matter what the underlying investments are. Whether arrangements amount to a mutual fund depends on three conditions (conditions A to C), all of which must apply to the ‘participants’ of the arrangements that broadly have the characteristics of pooled investments.
- Condition A requires that the purpose or effect of the arrangements is to facilitate pooled investments which enable the participants to ‘participate in the acquisition, holding, management or disposal of the property, or to receive profits or income from those transactions or sums paid out of such profits or income’.
- Condition B is that the participants do not have day-to-day control of the management of the property.
- Condition C requires that a ‘reasonable investor’ would, as a participant in the arrangements, expect to be able to realise all or part of an investment in the arrangements on a basis calculated entirely or almost entirely by reference to either:
- the net asset value (NAV) of the scheme property; or
- an index of any description.
‘Participants are the beneficial owners’ of interests in the arrangements or the property underlying the arrangements, whether or not they have legal ownership of their interests.
‘Realisation’ of an investment has a wide meaning, and so it may be by redemption, by sale to a third party, or by distribution of assets on the termination of a fund. For example, if a fund has a limited life, it would not matter that an investor may not be able to sell their shares or units on the open market for a sum representing NAV or close to NAV, as there would be an expectation that the investment could be realised at or close to NAV when the fund terminated.
A ‘reasonable investor’ is not defined in the legislation. So it is assumed that such an investor (whether an individual, corporate investor, or otherwise) would have read the investment documentation and taken account of all additional material and communications of any nature whatsoever provided by the mutual fund before investing.
What should I be aware of about Indian Mutual Funds?
This article was only intended to be a whistle-stop tour through offshore funds and mutual funds. UK resident investors and their trusted advisers are recommended to take appropriate specialist UK tax advice in this regard. We are mostly concerned about the complexities around investing in non-reporting offshore funds, for UK tax purposes.
Key points:
- The mutual fund industry in India is sizeable
- This has resulted in exponential interest from investors around the world, and thus the booming funds industry in India, as well as internationally
- The ‘offshore funds tax regime’ applies to Indian Mutual Funds
- HMRC’s offshore reporting funds list did not feature a single Indian fund, so advisers may struggle to identify the type of offshore financial product their clients have for UK tax purposes
- Approved ‘reporting’ offshore funds are taxed very differently to unapproved ‘non-reporting’ offshore funds
How are investments in Mutual Funds taxed in the UK?
While this article focuses on investments made into Indian mutual funds, the principles equally apply to other mutual funds and non-UK/offshore funds more generally too.
Readers will appreciate that UK residents increasingly invest in Indian mutual funds with many having done so for some time already. This is through their own research and active management of their financial investments or by encouragement from their wealth managers in India. HMRC’s approved offshore ‘reporting funds’ list is updated on a monthly basis. Interestingly, we noted that it did not feature a single Indian fund!
This is a list of offshore funds that have successfully applied to HMRC for ‘reporting fund’ status. The total number of identifiable sub-funds towards the end of 2021 appeared to be about 88,000 (of which some 62,000 were still active), while the unique fund reference numbers suggested about 3,700 approved/ reporting offshore funds.
Readers should note that Indian mutual funds were not on that list, and there were several hundred of them even in 2021. This is where the UK taxation complexities start, and why so many advisers struggle to identify the type of offshore financial product their clients have.
Why does HMRC have a list of approved offshore funds?
For the avoidance of doubt, approved ‘reporting’ offshore funds are taxed very differently from unapproved ‘non-reporting’ offshore funds, and so the differentiation is important to grasp for annual tax compliance work and when preparing tax disclosures for clients regularising past errors in their personal tax returns.
From our experience, regular advisers ought to be looking to identify some or most of the following:
- fund’s name;
- any reporting fund reference;
- any previous distributing fund reference;
- any sub-fund reference;
- any international securities identification (ISI) number;
- any stock exchange daily official list (SEDOL) number; and
- any Committee on Uniform Securities Identification Procedures (CUSIP) number.
This information is usually found on the offshore financial product’s prospectus, performance report and other records issued by the mutual fund to the investor or participator. The existence of this information will help match it to HMRC’s approved/reporting offshore funds list. If the offshore fund is not included though, then it will by default be an unapproved / non-reporting offshore fund.
By contrast though, where investors own their underlying financial assets themselves, which are usually identifiable from their shares and stocks records or on their statements for any portfolio investment accounts, they will likely not have an offshore fund. For examples, they will have ‘Demat’ or ‘PMS’ (Portfolio Management Service) accounts. They will have direct and distinct holdings hence
ownership of the investments, i.e. those will not be a ‘pooled investment’ and they will be able to exercise day-to-day control of the underlying investment’s management. In these circumstances, the investor will be liable to UK income tax on items such as interest, coupons or dividends, and to capital gains tax on the disposal of financial assets such as shares and bonds as normal, subject to any double taxation relief.
One then needs to consider the UK tax consequences of reporting and non-reporting offshore funds. To be clear, HMRC favours reporting funds, because the quality of the offshore fund’s performance reporting meets higher standards. This enables investors to clearly identify gains and losses arising within the fund, and thus their own share of those results. It follows that the UK capital gains tax regime applies in these situations.
Conversely, in the case of non-reporting funds, HMRC does not consider the offshore fund’s performance reporting to be adequate or the offshore fund has not applied to HMRC to successfully attain ‘reporting’ status. So, any losses arising from withdrawals or surrenders from those funds are still treated as capital losses, whereas the gains are liable to income tax instead. We do not cover the offshore income gains tax regime here further for the sake of brevity. Notably, the difference means that losses can only be used against capital gains, while any offshore income gains are taxed at much higher marginal income tax rates than those for capital gains tax.
See our expert article for Taxation magazine on Indian Mutual Funds here.
Also, detailed information and relevant legislation about the ‘offshore funds tax regime’ can be found at: HMRC’s Investment Funds Manual. It explains how UK-resident investors are treated for UK tax purposes, under the current regime, at part 8 of the TIOPA 2010 and the Offshore Funds (Tax) Regulations 2009.
A review of the Indian Mutual Funds market
In an attempt to put the size of the mutual funds industry in India into context, we ascertained that the assets under management (AUM) there crossed 30tn Indian rupees (INR) for the first time in November 2020. By 30 September 2021, the industry had increased to INR36.74tn; that is about £350bn!
These figures came from the Association of Mutual Funds in India, which is the official association of all the asset management companies of registered mutual funds in India, incorporated in 1995 as a non-profit organisation. At that time, we understood that all 45 registered companies were its members.
We also noted that the Indian mutual funds industry’s AUM had grown from INR15.8tn on 30 September 2016, which is more than a two-fold increase, in a span of only five years. Plus, the total number of mutual funds accounts (or folios as they are referred to in India) stood at a huge 111.7m as of 30 September 2021. Folios are numbers designated to individual investor accounts, so an investor can have multiple folios.
By any stretch of the imagination, these are eye-watering numbers which, no doubt, continue to contribute to the exponential interest from investors around the world, and thus the booming mutual funds industry in India (and internationally). This is in no small part due to the extensive groundwork done by mutual funds houses and Indian financial advisers, and the proliferation of technology, in educating and shepherding investors.
How we can help with Indian Mutual Funds?
If you are unsure as to whether a voluntary tax disclosure is required, we recommend that you speak to tax investigation specialists. We could assist in evaluating the facts and paperwork, and preparing a Worldwide Disclosure Facility (WDF) disclosure, ensuring taxes are minimised wherever possible, reducing statutory late payment interest exposure, protecting you from offshore penalties, and best managing HMRC. Also, the streamlined approach ensures that HMRC do not open an enquiry or serious investigation, which means the disclosure process can be managed informally and there is no need to meet any HMRC officers.
If you or your client has been contacted by HMRC about making a WDF tax disclosure then we can help steer that process, to keep it on track and focused, and bring about a speedy conclusion. Importantly, we deliver that all-important trusted ‘buffer’ between our clients and HMRC during the preparing, submission and verification of tax disclosures, as well as during their in-depth and intrusive investigations.
Get in touch to learn more about how Amit and the Tax Investigations and Disputes team have successfully guided clients through the Worldwide Disclosure Facility, Let Property Campaign disclosures, compliance checks, and COP9 or COP8 investigation processes.
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HOW CAN PURE TAX HELP?
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