What’s the deal with offshore funds?
The debate over David Cameron's interest in an offshore fund set up by his late father has shed a light on these investment vehicles – and how common they are.
UK investors have access to over 4,000 offshore funds that have a combined value of £1.9 trillion, with the majority of the funds domiciled (based) in Luxembourg or Dublin. For tax purposes, there are two types:
- Reporting funds: these provide HMRC details of the income that they generate. UK tax payers pay Income Tax and CGT.
- Non-reporting: These don’t report to HMRC and therefore UK taxpayers pay Income Tax on the whole return (income and gains).
Fund management companies can benefit from savings on regulation, structure costs and tax rates. Luxembourg has always prided itself on applying the lowest VAT rates in the EU and has signed over 68 double tax treaties to date.
UK tax-residents are very unlikely to derive any tax benefit from choosing to invest in an offshore fund
For investors, there are some investment strategies that are difficult to find onshore, such as hedge funds, or more specialised funds. Sometimes it is possible to find funds run by fund managers who are well-established in this country that offer slightly different strategies to their onshore equivalents. In other cases, the offshore versions remain open while the UK funds have been soft-closed. Offshore funds can also make more sense where investors want to hold funds in specific currencies.
The trade-off is that the investor protection may not be as good as in the UK, but this is generally only the case outside Europe.
UK tax-residents are very unlikely to derive any tax benefit from choosing to invest in an offshore fund compared to investing in a UK-based fund. Any British citizen can put their money into an offshore fund in a tax haven and receive their gains tax-free. But they have a legal duty to declare these earnings to HMRC in their annual tax return, just as you would if you were investing in a UK-based fund. Not doing so is pure tax evasion.
Confusion has arisen around the David Cameron-Panama Papers dispute, because in common language, investment funds and trusts can be interpreted as the same thing. The term ‘offshore trusts’ also describes a well-established mechanism for complex planning needs. They are widely used by British expats that have no liability to the likes of income or capital gains tax in the UK. They are also used by wealthy individuals who are resident in the UK, but not ‘domiciled’ here. An example would be a Russian oligarch living in Mayfair setting up an offshore trust so he avoids paying tax in the UK on his worldwide assets.
New, global common reporting standard
From September 2017, 96 countries will automatically exchange information with the tax authorities about the owners of trusts and the amount of money in them. Most tax havens have signed up, apart from one – Panama!