The upshot: offshore growth is ‘unstoppable’

The inclusion of offshore funds in the IMA sectors has made judging the suitability of these funds easier for advisers.

Historically, offshore funds were the preserve of the super-rich as a way of avoiding tax on their investments.

However, in 1984 a tax regime for UK investors was introduced by HMRC to counter the ability for investors to accumulate income in an offshore fund free of tax and, upon realising the investment, only paying capital gains tax rather than on the income earned.

These rules have been further updated, most recently within the Finance Act 2008 and supplemented by regulations in the Offshore Funds (Tax) Regulations 2009.

According to the HMRC Offshore Funds Manual, the 1984 legislation was “established on the basis that if an offshore fund did not distribute at least 85 per cent of its income then, on disposal of interests in the fund, UK investors would be charged tax on income rather than on capital gains.”

It adds: “This was to prevent the possibility of rolling up income in an offshore fund, with any subsequent disposal being subject only to tax on capital gains, rather than being charged to tax as income.”

However, the updated rules published in 2009 shifted away from the requirement placed on offshore funds to distribute income, so that UK investors could benefit from “more favourable capital gains treatment on disposals of interests”.

It is this distinct difference that requires advisers to pay particular attention to whether the fund has ‘reporting’ status.

A reporting status means a fund is required to report 100 per cent of the fund’s profits to investors and they are only taxed on their share of the reported income, regardless of whether or not it is paid out or reinvested in the fund itself.

Bob Jenkins, global head of Lipper Research, says: “There is an inherent benefit if you are not forced to pay tax on capital gains and distributions and you are allowed to reinvest.”

The other important consideration an adviser has to make relates to the reliability of the offshore fund, because they are not eligible for the investor compensation scheme that UK-domiciled funds are.

Rob Burdett, co-head of multi-manager at F&C, explains: “If an investor invests directly in an offshore fund, they are not eligible for the investor compensation scheme should anything happen.”

However, he adds: “If that investor gains exposure to offshore funds through a fund of funds, for example, it is the overall investment in the fund that is counted and therefore they would be eligible for the compensation scheme.”

Mr Burdett says he has been investing in offshore funds within the F&C Navigator range (previously Thames River Multi-Manager range) for several years.

“Lots of multi-manager funds like us have always used offshore funds and we have systems that allow us to view offshore peer groups, we can cross-refer them with the IMA sectors and make a judgement on that. Typically half of our funds are domiciled in Dublin or Luxembourg,” he explains.

“What we find is if a fund group is based

in Europe, continental Europe or the US, and they are looking to expand their horizons – then a pan-European base is a better option because they can be sold into the UK, into Europe and, to an extent, into other borders as well.

“The Ucits guidelines, or rules for the funds, are well known globally and Dublin and Luxembourg are the primary hubs for that, although other locations for that are falling into place now.”

The reasons for ‘going offshore’ have changed – moving away from tax benefits and towards portfolio diversification – and advisers, therefore, have to judge both offshore and onshore products in the same light.

Mr Burdett explains: “There is some history of offshore funds being more expensive in the underlying hidden charges, or those outside the annual management fee, and regulation is very slightly different, but Ucits funds are considered by the FCA as of equivalent quality in terms of regulations.

“Advisers should concentrate on the investment manager and process and treat these things as boxes you have to tick to get comfortable with the fund.

“It is good news that there is more choice for investors, [the inclusion of offshore funds in IMA sectors] is gaining momentum and I know there are other companies that will be adding it over the years. It is unstoppable.”

Jenny Lowe is features editor at Investment Adviser