Exceptions to meaning of mutual fund: condition F: income subject to UK taxation - Section 357(7) TIOPA 2010
When S357(5) and S(357(6) are not satisfied the arrangements being considered may still meet the criteria of S357(4)(b) if S357 (7) is satisfied.
S357(7) is satisfied if all of the income produced by the assets that are the subject of the arrangements (after the deduction of reasonable expenses) is required to be paid or credited to participants in such a way that any participant who is a UK resident individual would be charged to income tax on the amounts so paid or credited. That would include, for example, sums that would be treated as offshore income gains generated by the sale of investments in underlying non-reporting funds.
‘Reasonable expenses’ is not defined, but HMRC will accept that expenses are reasonably deducted where they would, broadly, be deductible for a reporting fund in calculating its reportable income under Chapter 5 of The Offshore Funds (Tax) Regulations 2009. This would prevent, for example, capital items from being deducted.
S357(7) is framed in terms of individuals resident in the United Kingdom S357(b). So, provided that a fund distributes all of the income of the fund that would be chargeable to income tax in the hands of an individual UK resident and domiciled investor (if the asset producing the income was directly held by them) then the fund can satisfy S357(7). There is, of course, also be a requirement to distribute those amounts to corporate investors.
If a fund would face difficulty in determining the measure of income to be distributed on the above basis, for example because it is itself invested in another fund(s) and either the detail of the reporting by that fund(s) is insufficient for this purpose or the information is received late, then the fund may choose to distribute a measure of income determined in some other manner (for example, in accordance with that required for a reporting fund) provided it can be demonstrated that the sum distributed is at least that which would be required in order to satisfy S357(7).
S357(7) could in theory be satisfied if the arrangements being considered are transparent for income purposes. However, it would be expected that most income transparent entities / capital gains opaque entities that were capable of coming within the definition of an offshore fund, such as so-called “Baker” unit trusts and Fonds Commun de placement (‘FCPs’), would be open-ended (that is, the fund can issue or redeem units on request or at particular intervals) and as such none of the exceptions in S357 could apply as Condition D has the effect that the exceptions can only apply to closed-ended arrangements. Regulation 29 of The Offshore Funds (Tax) Regulations 2009 does, however, permit such funds to remain non-reporting funds without an offshore income gain arising to investors disposing of their interests in them subject to certain conditions - see OFM16500 for details.
Condition F will not be met where the arrangements are designed to produce a return for investors that is equivalent, in substance, to interest and such arrangements will therefore meet the definition of a mutual fund and will be an offshore fund (section 357(4)(c) TIOPA 2010 - see OFM06300).