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Offshore funds: A double sting in the tax tail?

Offshore funds: a double sting in the tail?

Offshore funds can have unexpected tax liabilities. Soon, they could also put you in breach of HMRC’s Requirement to Correct rules.

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Offshore funds: a double sting in the tail?, Image of white deck on water

Offshore funds are a common investment strategy. But, they can have hidden tax implications for individuals and trustees. 

Excess reportable income

Offshore investment funds – including popular exchange-traded funds like iShares – may not distribute all of the profits they make in a given year to their investors.

There are two main reasons for this. The fund may have a distribution policy that stipulates reinvestment of a proportion of the profits. Or the fund managers may simply decide it’s the right strategy for the fund at a particular point in time. 

But, since 2009 undistributed profits from certain tax-compliant offshore investment funds (known as ‘reporting funds’) have been liable for income tax. These profits are known as excess reportable income (ERI).

Those managing reporting funds have chosen  to fall within the ERI regime so that investors can receive capital gains tax treatment on a sale at 20%, rather than income tax on the profits from the sale at 45%.

The upshot is that investors in funds with ERI may have:

  • An income tax liability on any undistributed profits dating back to 2009 – even though they never received the income in question; and 
  • A duty to report these profits in their tax returns, in the same way they do with actual cash distributions from their offshore reporting funds. 

Blind spots

The problem is that investors might not be aware of this liability. 

They probably don’t even realise there are undistributed profits in their offshore funds. This information is not easy to come by, as wealth managers typically struggle to provide ERI information in their year-end tax reports. 

In fact, the small print at the end of these reports often states ERI has not been included and that investors should consult their tax advisers. But, tax advisers may also not be aware of ERI either. And, even where investors are aware of ERI, they may (quite reasonably) assume they don’t owe tax on income they have not received. 

There’s also a misperception that ERI tax liabilities tend to be insignificant. Unfortunately, this isn’t the case. In any event, HMRC is duty-bound to pursue all unpaid tax, no matter how small the amounts. 

The reality is that ERI tax liabilities can easily amount to thousands of pounds. For higher-rate taxpayers, ERI attracts income tax at 45% for bond funds and 38.1% for equity funds. And, of course, investors may have money in several offshore reporting funds.

Requirement to correct

There’s another potential sting in the ERI tail. HMRC has confirmed that ERI will fall within its new Requirement to Correct (RTC) regime. 

RTC imposes unprecedented penalties on any UK tax liabilities from offshore assets that go undeclared after 30 September 2018. Fines will total at least 100% of the undeclared liability, and potentially up to 200%. 

Furthermore, HMRC has also announced it will ‘name and shame’ individuals who fail to declare offshore income.   

These rules don't just apply to individual investors; trustees can also incur financial penalties for non-compliance.

The way forward

To avoid these sanctions, we strongly recommend disclosing any undeclared ERI to HMRC before the end of September 2018. 

As a first step, you can use our free tool to check whether your offshore investment funds have any ERI for the tax years since 2009. 

If so, then you’ll need to:

  • Check whether that income has been declared on your previous tax returns; and
  • Make any necessary corrections with HMRC before 30 September 2018. It’s essential you consult a tax adviser when doing this, because the rules surrounding offshore funds and RTC are complex.  

Find out more

You can read more about RTC in our last issue of Personal Perspectives.

If you’re unsure about your offshore tax status in light of RTC, KPMG’s tax experts are on hand to help. We advise individuals, funds and trustees on these issues, so are well versed in the complexities on both sides.

Please contact Jo Bateson if you have any further questions.

 

 

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