Policy paper

Statement of Practice 2 (1986)

Published 7 March 1986

1. This statement sets out HM Revenue and Customs view on the interpretation of certain provisions of this legislation, on which queries have been raised.

Material interests in offshore funds

2. The legislation applies to ‘material interests’ in offshore funds. For such an interest to exist, the investor, at the time of acquiring his investment, must have a reasonable expectation of being able to realise it within 7 years for an amount reasonably approximate to that portion which the investment represents of the market value of the entity’s underlying assets.

Investments in commercial loans and bonds

3. Normal commercial loans or other debt instruments which entitle the lender to no more than a fixed return of principal on redemption, and which are not geared to the underlying asset value of the borrower’s business, would not be regarded as a material interest within the legislation.

Stock Exchange listings of shares

4. Where shares in an overseas company are listed on a stock exchange, it is possible that the quoted price will on occasions correspond to underlying net asset value. This will however not of itself make the shares a material interest in an offshore fund. The shares would be considered a material interest only if, at the time they were acquired, the investor had a reasonable expectation of a future sale at or near net asset value. If historically the shares have been habitually traded at or near net asset value an investor is likely to have acquired a material interest.

Conditions for distributor status

5. The legislation divides offshore funds into 2 groups:

• distributing funds, which must:
  • meet specified investment restrictions and
  • distribute at least 85% of their income (as computed in their accounts) and 85% of what would be their taxable profits were they UK-resident companies (the ‘UK equivalent profits’) and
• other funds

Computation of what would be the UK equivalent profits

(a) Is the fund trading?

6. Where a fund is regarded as trading, the resulting profits will be brought into the computation of UK equivalent profits. Whether the activities of an offshore fund amount to trading will turn on the facts of the particular case and it is not possible to give any specific guidance on this aspect. Even a single transaction can on occasion constitute ‘an adventure or concern in the nature of trade’ but in general a fund would not normally be regarded as trading in respect of transactions which were relatively infrequent or, for example, where the intention was merely to hedge specific investments which were not associated with activities which themselves constituted trading.

(b) Interest paid by offshore funds to non-residents

7. In arriving at the computation of UK equivalent profits, a deduction is available for interest paid by a fund to a person resident outside the UK in the same way as it would be if the interest were paid to a UK resident.

(c) Income taxed in the UK

8. Where an offshore fund receives income that has suffered tax at source in the UK, it is the net income (rather than the gross) that is included in the calculation of the UK equivalent profit.

9. A deduction will also be available for any tax suffered by direct assessment in the UK. The basis of the relief will be determined by reference to the individual case.

Note: this Statement was revised in August 2005.