Finance and Tax Blog for individuals and companies

Cyprus an EU member state since 2004 and part of the Eurozone since 2008 provides an attractive and cost efficient investment funds location bridging the Middle East and Europe for UCITS; non-UCITS including private equity type funds and Real Estate; local domestic funds; and investment managers and fund administrators. The industry is regulated by the Central Bank of Cyprus for private investment funds and Cyprus Security and Exchange Commissions for UCITS.

Cyprus has the lowest corporate tax regime in the EU at 10% together with over 43 double tax treaties (Source: Ministry of Finance) which are open to its domiciled investment funds. In particular it has DTTs with many Eastern European countries, Russia, China, India, Singapore, Kuwait, UK and the USA. A full updated list of countries is located at www.mof.gov.cy

It has put in place an internationally acceptable transparent tax system and is accordingly on the Organisation for Economic Co-operation and Development (OECD) tax white list. Companies are exempt from tax on most dividend income received and profits from disposal of shares and securities. Also there is no withholding tax on dividends paid to non-resident shareholders and generally has a favourable tax regime for investors.

Cyprus employs a common law legal system and is an ideal hub for doing business in Russia, Eastern Europe, Middle East, Gulf States, Asia (including China and India) and Africa. Cyprus’ languages include Greek, English which is widely used in international business and Turkish.

Cyprus fully applies EU law and has subscribed to the EU directives on UCITS IV and Alternative Investment Fund Managers (AIFMD) so it has adopted the management of funds passport directive, can be a useful alternative location of hedge funds and the infrastructure to support cross-border and global fund distribution.

HMRC have announced that amendments to the Offshore Funds Tax Regulations will come into force on 27 May 2011. These relate to UK AIF QISs and are detailed in our article Offshore Reporting Funds – Equivalence and GDO Conditions of 10 March 2011.

Amendments are being made to improve the practical operation of the UK Reporting Fund regime which has been in place since December 2009 following publication in February 2011 of a various proposals in draft regulations which are now set out in final form in The Offshore Funds (Tax) (Amendment) Regulations 2011 and will come into force on 27 May 2011.

In particular the draft outlined changes to the rules on income equalisation with a view to eliminating the ‘last man standing’ issue which could arise where a reporting fund does not operate equalisation. The concern was for investors remaining in a fund at the end of the reporting period being allocated a disproportionate amount of fund income for tax purposes which would not be a welcome outcome for higher rate tax paying individuals.

In summary, the draft regulations proposed some form of income equalisation or income adjustment be mandatory for reporting funds but this requirement has been relaxed to include a further alternative of ‘do nothing’. Therefore, it will be possible to apply no equalisation or income adjustment although it is still necessary to advise HMRC of this option.

The original proposal was intended to make the allocation of fund income on the basis of either accounting income or reporting income across all investors fairer taking into account incoming and outgoing investors during the reporting period.

In the case of new reporting funds managers must determine at the outset the method of equalisation employed (if any) by the fund and notify this to HMRC on the initial application to join the reporting fund regime. For funds already in the regime managers have until the 27 May 2012 to notify HMRC of the method of equalisation (if any) that will apply going forward. It should be noted however that a failure to make such a notification to HMRC within this timeframe will deem the fund to have elected to make income adjustments on the basis of reported income.

This flexibility will be welcome news to a number of managers who in particular manage investment products with emphasis on capital growth where income is of a secondary nature.

The Organisation for Economic Co-operation and Development (OECD) has recently launched a consultation document on proposed changes to the Model Convention Commentary in respect of the term ‘beneficial owners’ set down in Articles 10, 11 and 12. These Articles cover dividend, interest and royalties and are on interest to offshore funds wishing to establish their entitlement to access lower rates of withholding tax on investment income in applicable double tax agreements. In particular Funds domiciled in Dublin or Luxembourg frequently look at this issue as it impacts investment return.

The term “beneficial owner”, as used in the above Articles of the Model Tax Convention, has given rise to different interpretations by courts and tax administrations. Given the risks of double taxation, and non-taxation, arising from these different interpretations, the OECD Committee on Fiscal Affairs (CFA) through its Working Party 1 on Tax Conventions and Related Questions, has developed proposals aimed at clarifying the interpretation that should be given to that concept in the context of the OECD Model Tax Convention.

This discussion draft includes the proposed changes to the Commentary on Articles 10, 11 and 12 of the OECD Model Tax Convention that the Working Party has drafted for that purpose. There is no definition of beneficial owner in the Model Convention. However, in practice interpretation appears to be based in many cases on local domestic law which was not the original intention behind the guidance given by OECD.

The Committee intends to ask the Working Party to review these proposed changes in light of the comments from all interested parties. It therefore invites comments on this discussion draft before 15 July 2011. These comments will be examined at the September 2011 meeting of the Working Party.

It is evident from the HMRC website that many offshore funds joined the UK tax reporting regime with effect from 1 January 2010. Such funds will now be preparing the information on reportable income per share class to be sent to HMRC and its participants (investors).

The report must be made available to participants within a period of six months beginning with the day immediately following the final day of the reporting period. Therefore, funds with a 31 December 2010 year end will have to make such information available to participants by 1 July 2011 and in turn to HMRC by 30 June 2011.

However, it is now coming to the attention of some fund managers that certain shares classes brought within the scope of the UK reporting fund regime have to the reporting year end date not attracted any UK resident participants. For this purpose the Regulations state that a relevant participant means investors who are resident in the UK for tax purposes; it does not apply to overseas investors.

The Offshore Funds (Tax) Regulations 2009 provide that Reporting funds are required to make available a report to each of their relevant participants who hold an interest in the fund at anytime during the reporting period in question. This is to enable UK resident investors to make a return of their proportionate share of reportable income. This information can also be used by investors who are in turn reporting funds in computing their own reportable income.

Therefore, if the fund concerned has no UK investors it will not be required to make a report available. However, the fund will still be required to comply with their reporting requirements to HMRC given as one of the conditions when the fund applied to HMRC to join the UK reporting fund regime.

Article 5 of the UCITS IV Directive provides that UCITS funds may be managed by an authorised fund manager resident in an EEA member state other than the home state where the fund is established and regulated. For this purpose the EEA includes member states of the EU together with Norway, Iceland and Liechtenstein; it does not, however, extend to Switzerland.

The Management Company Passport (MCP) will therefore apply to collective investment schemes established and regulated in an above EEA member state.

In Budget 2011 the UK Government following consultation on the transposition of UCITS IV introduced a tax relieving measure to cover an offshore UCITS IV fund managed by a UK fund manager. This measure maintains UK competitiveness in the asset management industry by ensuring that there will be no adverse tax consequences in the UK when a foreign UCITS fund appoints a manager resident in the UK for tax purposes. Under current case law some foreign funds may be held to be tax resident in the UK when centrally managed and controlled here
.
The measure provides legislation to treat offshore UCITS funds as not being resident in the UK for tax purposes in cases where they might otherwise be resident by virtue of the activities of the UK fund manager. The proposed legislation has been included in the Finance Bill 2011 and will come into effect upon Royal Assent.

At the end of last year the European Commission published a Green (Consultation) Paper on the future of EU VAT seeking the views of all stakeholders on how to make it work better for European businesses and citizens. This will be of particular interest to financial services firms since many of their products are exempt from VAT with restriction on recovery of input tax. Calculating such recoverable input tax is an administratively complex area leading in many cases to disputes about the partial exemption methodology adopted by firms affected.

The paper addresses 33 questions on the overall system of VAT and the need for a simpler and more modern regime to accommodate today’s business environment; responses are invited by 31 May 2011. In particular the paper addresses four main issues:

• Cross border transactions within the EU
• Whether any of the current VAT exemptions should be abolished. This impacts such areas as healthcare, education, charitable activities and services including insurance
• Improving the VAT system by reducing ‘red tape’ and introducing further simplification
• The administration of VAT by national tax authorities

Further briefings will be issued as more news comes to hand.

HMT and FSA issued on 22nd December 2010 a consultation on implementing the above directive. A missing link, however, is that the UK does not have a tax transparent vehicle to enable efficient working of master feeder fund structures and as a result the Government indicated that they would bring forward a suitable vehicle platform in 2012. In the 2011 Budget it has been now acknowledged that consultation will take place in June 2011 with the Funds’ industry on tax transparent vehicles. Currently, however, such structures work effectively in Dublin and Luxembourg and for fund sponsors in this area there is a viable alternative to move forward.

The European Commission has launched a consultation on taxation of cross-border dividend payments to individual or portfolio investors and invites comments by 30 April 2011. In particular this area impacts offshore funds and pension funds in receipt of portfolio dividends including lack access to an applicable double tax treaty to eliminate or reduce such withholding tax. Also there is often discrimination between the treatments of dividends paid to domestic investors and non-resident investors.

The aim of the consultation is to deal with levying and crediting of withholding taxes on dividend payments to non-resident portfolio and individual investors in the EU which can sometimes be carried out in a discriminatory way. Withholding taxes can, in addition, lead to unrelieved double taxation, distorting the effective functioning of the Internal Market.

In its Dividend Taxation Communication of 2003, the Commission pointed out that Member States could not discriminate in their tax treatment of cross-border dividend income received by individuals. The Court of Justice of the European Union had dealt in several judgments with withholding taxes on dividend payments to non-residents.

Drawing from this case-law of the Court of Justice, the Commission concluded that Member States cannot levy higher taxes on inbound dividends than on domestic dividends. Similarly, they cannot levy higher taxes on outbound dividends than on domestic dividends.

The Commission presents seven different options to resolve the problems created above:

• abolition of withholding taxes on cross-border dividend payments;
• state of residence grants full credit for withholding taxes levied in the source state;
• net taxation in the source member state;
• EU-wide reduced withholding tax rate with information exchange;
• limitation of both source and resident taxation of dividend income;
• neither withholding state in the source state not taxation in the residence state; and
• source state levies withholding tax at the tax rate of the residence state which is paid to residence state.

As expected further to an earlier announcement on 20 December 2010 dealing with equalisation arrangements, HMRC published on 28 February 2011, for comment, a full draft of proposed amendments to The Offshore Funds (Tax) Regulations 2009 (SI 2009/3001 (as amended) which is proposed to come into force before the end of May 2011. In summary the proposals cover:

• Rules including transitional provisions to enable adjustments to the calculation of reported income per unit for reporting funds not operating equalisation arrangements to eliminate the possibility of the “last man standing” problem. This concern had been highlighted in particular in the melt down of some investment funds due to volatile market forces;
• Extension of the UCITS and FSMA recognized conditions for reporting funds to cover other EEA retail and professional only offshore funds similar to UK qualified investor schemes. This gives such funds possible access to the HMRC white list on trading v investing.
• Alterations to the Genuine Diversity of Ownership rule to allow it to apply at sub-fund level (and not just share class) and to permit investors in a feeder fund to be considered when assessing a Master fund.
• New rules for calculating the reportable income of a transparent reporting fund.
• A provision to give more certainty to the computation of reportable income in an index tracking fund.
• An extension of time limits for application of entry into and withdrawal form the reporting regime.
• Clarification of scope of reporting requirements (to ‘relevant’ investors).
• Non-reporting funds invested almost entirely in unlisted trading companies gains arising on the disposal of shares will be exempt the charge to tax on offshore income gains.
• Fiscally transparent funds will be outside the scope of legislation which treats holdings in certain funds as loan relationships (for corporate investors). This will have the effect that corporate holders will ‘look through’ all transparent offshore funds for tax purposes including those that are mainly invested in interest bearing assets. The loan relationships rules will therefore apply directly to the underlying assets where relevant.