KPMG Warns Offshore Fund Managers Over Tax Status In UK

by Jason Gorringe, Tax-News.com, London

24 October 2006

New draft guidelines have been published under which UK-based investment managers of offshore funds could see their funds’ profits losing their tax-free status in certain circumstances, according to Big Four accounting firm, KPMG.

HM Revenue and Customs (HMRC) has published new draft guidelines on the tests which investment managers need to satisfy to qualify for the “Investment Manager Exemption (IME)” enabling profits from offshore funds to remain outside the UK tax net.

Affected UK-based investment managers have until 12 January 2007 to comment on the draft proposals.

KPMG tax partner, John Neighbour, formerly of the OECD and HMRC, where he was in charge of the review of the tests for the IME, warned that:

“These new draft guidelines are of huge significance to investment managers, particularly in ‘alternatives’ such as hedge funds. Assuming these new draft guidelines are adopted, they will all need to review their arrangements as a matter of extreme urgency in order to ensure that the funds for which they act maintain their tax free status. We expect most fund managers to adapt their arrangements as necessary in order to remain in the UK and keep the funds’ tax free status.”

The key changes in the new draft guidelines affect the following two tests:

1. The “customary remuneration” test

2. The “independence” test

Under the current customary remuneration test, an investment manager of an offshore fund needs to demonstrate that the remuneration received for this management service is not less what is “customary” for that class of business. There has been little guidance as to what is meant by customary but under the new draft guidance, HMRC confirms that it will determine whether this remuneration is “customary” by applying the transfer pricing concept of arm’s length pricing.

Mr Neighbour commented:

“An element of certainty of what HMRC actually means by the term ‘customary’ is welcomed as is the reference to internationally accepted transfer pricing principles as found in the OECD Transfer Pricing Guidelines. However, it does make satisfying this test more onerous. Applying transfer pricing methodology means that UK fund managers will need to ensure that they can demonstrate all amounts paid to parties related to their funds are at arm’s length rates and, in this sense, the burden of proof that the arrangements are satisfactory shifts from HMRC to the UK fund managers.”

In contrast to the changes to the remuneration test, the new draft guidance on the independence test introduces further uncertainty. The previous guidance set out a list of circumstances under which HMRC will regard the independence test to be satisfied. The new draft guidance now states that no one factor will be treated as decisive in determining whether the manager and the fund are independent; the list merely illustrates what may be significant.

Neighbour concluded by observing that:

“These moves are the latest steps in the increasing level of scrutiny HMRC is applying to the fund management industry. There is a perception that some fund managers have played a little ‘fast and loose’ and HMRC is tightening up the rules in response. Everyone in the industry will need to pay attention to these proposed changes and, at the very least, review their procedures. We would expect that most will satisfy the new guidelines but some will have to make some changes to their arrangements very quickly.”

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