Offshore bond market boom at an end?

As part of the October pre-Budget report, HM Treasury is proposing to scrap two regulations which are needed for a fund to gain UK distributor status. The first rule up for abolition is the requirement to physically distribute 85% of a fund’s annual income to UK investors. The government also wants to abolish the rule banning offshore funds from investing more than 5% of net assets in other offshore funds

In addition, distributor status – which is required by an offshore fund so it qualifies for capital gains tax on returns – will be known as ‘reporting’ or ‘non-reporting’ under the changes.

In a briefing document on the proposals, PricewaterhouseCoopers said both changes are “clearly attractive features’.

However, it warned that the replacement to the need to physically distribute cash could result in extra cost to the fund industry.

“Offshore funds will have to report income to UK investors and the HMRC,” it says.

“This has the potential to create a significant administrative burden for fund promoters.”

At Schroders, the group’s head of fund regulatory strategy, Simon Vernon says the group wis looking at the tax regime proposals from the point of view of Fund of Alternative Investment Funds rules.

“This is a step in the right direction in terms of the FSA consultation for FAIFs,” he says.

“It seems HM Treasury has listened to what the industry and what the FSA are trying to do.”

In particular, the removal of the 5% rule paves the way for regulated fund of hedge funds that are domiciled offshore but can be distributed easily to the UK.

“The devil is in the detail,” Vernon adds. “But once the offshore fund regime is relaxed it is a good indicator that HM Treasure will see onshore funds in the same light.”

James Cobb, technical manager at Hargreaves Lansdown, believes the proposals are a further signal that the HMRC is targeting anti-avoidance.

“Every new bit of legislation seems to be attempting to close tax avoidance loopholes,” he says.

“Currently if a UK resident buys an offshore non-distributor fund and then moves abroad for a couple of years, he can cash these in and not be liable to UK tax. However, with distributor funds you must be non-resident for five years.”

Cobb says that overall the proposals will not make a huge difference to either the adviser or client.

Elsewhere, thoughts are on how the offshore bond market will be affected by the proposed change to capital gains tax rates. In recent years the market got a push from rapidly appreciating house prices in the UK, which necessitated use of measures to reduce exposure to inheritance tax (IHT). The introduction of flat rate 18% CGT and removal of taper and indexation relief is seen to have a detrimental effect.

Hargreaves Lansdown is among those firms conducting a review of its advised investment bond sales. Its head of financial practitioners Danny Cox suggests the new CGT rules have thrown financial planning “into chaos” and could cause the offshore market to shrink.

“The main market for offshore bonds is higher rate tax payers. Why would you now use an offshore bond where the tax will ultimately be 40 per cent when you can stay onshore in collectives or shares and not pay more than 18 per cent?”

Cox says bonds may still be suitable for trusts, certain basic rate tax payers who need income and who might be caught by the age allowance trap, and for IHT planning.


1 November 2007