Memorandum from the Investment Management
1. The Investment Management Association
(IMA) represents the UK-based investment management industry.
Our members include independent fund managers and the investment
arms of retail banks, life insurers and investment banks. They
are responsible for the management of £3.4 trillion of funds
(based in the UK and elsewhere), including authorised investment
funds, institutional funds, and a wide range of investment management
services for private and institutional investors. In particular,
our members represent 99% of funds under management in authorised
2. These clients are both sizeable and international.
Some £500 billion is managed within "UCITS" and
other authorised funds, and a little under £1 trillion is
managed for each of pension schemes and insurers. Other institutional
funds, including sovereign wealth fund clients, provide almost
all the remaining balance. To put this in context, the UK-based
investment managers represented by the IMA manage investments
which are larger than the world's hedge funds and sovereign wealth
funds put together.
3. This submission focuses on the use of
pooled investment vehicles, where those vehicles are located in
offshore centres. The investment management industry makes significant
use of offshore locations as domiciles for their pooled vehicles,
which commonly means somewhere as un-exotic as Luxembourg, Ireland,
the Channel Islands or the Isle of Man. This submission explains
why this is the case, and how Government policy, notably in the
tax area, can contribute to it.
4. When determining where to domicile a
pooled investment vehicle, the principal concern is what is optimal
for the investors, bearing in mind that the returns earned belong
to themwhether they are pension funds, other institutional
funds or retail investors. The investment managers represented
by the IMA do not invest on their own account but act solely on
behalf of their clients whose assets are being invested. They
do not wish to be party to or vulnerable to any form of tax evasion
or terrorist financing.
5. In selecting a domicile for pooled investment
vehicles ("funds"), a manager will take into account
a number of factors, but the broad objective will be to deliver
the best outcome for the client and in the most operationally
efficient manner. Given the multinational nature of many investment
management businessesinvesting in many different jurisdictions
for clients from many different countriesit is clearly
efficient to concentrate operations in a small number of fund
ranges globally rather than to maintain different ranges in every
jurisdiction in which they operate. Thus, many investors worldwide
will see their money invested in funds outside their own country.
6. A number of factors will affect these
decisions: the extent and cost of expertise in the domicile; how
it fits in with other parts of the manager's business; and the
likely impact of regulatory and tax factors on investors' returns.
7. Recent years have seen significant growth
of offshore funds, notably in Dublin and Luxembourg, but also
in other centres such as the Channel Islands and Cayman Islands,
at the expense of UK-domiciled funds. A study by KPMG for the
IMA,"Taxation and the competitiveness of UK funds",
identified tax factors as key drivers of this trend.
8. This submission sets out the taxation
aspects for this industry, for funds and for investors. There
are, in certain circumstances, key fiscal uncertainties or clear
disadvantages with using a UK fund as opposed to its offshore
counterpart, especially where the same vehicle is intended to
be sold to UK and non-UK investors alike. The simple fact is that
the best location will tend to be selected. It is not the case
that the UK is the default locationthe UK must compete
with other territories as a fund domicile. In many cases, the
balance has been tipping away from the UK for some years and based
on recent trends the UK could in the foreseeable future become
a net importer of funds.
9. This has an impact on UK tax receipts
and the current account, because of the professional and administrative
activities which are carried out in the fund domicile rather than
in the UK. Further work by KPMG for the IMA
estimated that for every £1 billion of funds which were in
an offshore location rather than the UK, the cost to the Exchequer
was £0.7 million in terms of lost direct tax revenues. Overall
EU growth in retail funds has run at 1.5 times that of the UK
in the last 10 years, but Ireland and Luxembourg have achieved
growth rates of 10.7 and 2.6 times that of the UK.
10. If the UK were home to those funds domiciled
in Luxembourg and Ireland with a UK investment manager, the UK
direct tax receipts are estimated by the IMA to be equivalent
to £286 million
11. It should be emphasised that this is
not a call for lower taxes on UK funds (save in one very narrow
respect, where we have pointed to the impact of Schedule 19 Stamp
Duty Reserve Tax, which in total raises only £90 million)
and certainly not on investment management companies. Instead
it concerns the perverse impact of tax policies designed without
funds specifically in mind. A good example is the unclear distinction
between trading and investing for tax purposes, where the uncertainty
that investors could face a penal and difficult to justify tax
charge is an incentive to locate funds in a jurisdiction where
the risk does not exist.
12. The IMA is in dialogue with HM Treasury
about these matters. But we have been given no assurance from
Ministers that they will be solved, while, of course, the UK's
competitors do not stand still. Locations such as Luxembourg and
Ireland have made very impressive progress in attracting funds,
especially aimed at the European retail market. Likewise, the
Channel Islands and Isle of Man are able to offer attractive domiciles
to certain types of institutional funds.
13. In conclusion, the key points that the
IMA would wish to make to the Committee are:
There are good business reasons,
which benefit both investment management companies and end investors,
for locating certain activities offshore.
Some of those factors are the unintended
consequences of regulatory or, in particular, tax policies introduced
for entirely different reasons.
The IMA believes the Government should
pay greater attention to the impact on the competitiveness of
the UK as a place to do business when taking decisions on tax
14. This submission comments on the reasons
why investment managers may choose to operate "offshore"
and on the taxation implications for the Exchequer. The term "offshore"
is a widely-used one, and it is important to explain what is meant
by its use in the context of investment management.
15. The majority of the assets of institutional
investors (pension funds, life companies, sovereigns, etc) are
held under segregated mandates, where one investor's money is
held and invested separately from and not pooled with other investors'
money. The investor may be in one country, the investment manager
in the UK and the assets located worldwide. It is common for global
investment management houses to operate in a number of jurisdictions.
It is obvious that a business needs to have staff and offices
on the ground in order to handle marketing and client-facing aspects
(ie "distribution"). However, it is also common for
the contracted investment manager to delegate parts of mandates
to group or third party managers who specialise in eg geographical
sectors or certain asset classes. Equally, a UK investor may chose
to contract with a non-UK investment manager.
16. However, this is about an international
business model and is not about the use of offshore financial
centres as such. Of more relevance to the Committee's deliberations,
and therefore the area that this submission focuses on, is the
use of pooled investment vehicles, where those vehicles are located
in offshore centres.
17. To understand why investment managers
may chose to locate collective investment vehicles offshore, it
is necessary to separate the components of the business, being
the industry, the product and the investor, each of which, separately,
may be tax payers.
Components of the industry
18. The industry comprises those participants
involved in "manufacturing" and distributing the product.
The product for these purposes is a collective investment vehicle
(hereafter referred to as a "fund"), into which investors
may put their money. Many of these funds (though not all) will
fall into a definition contained in statute, the "Collective
A fund is an arrangement whereby investors come (or are brought)
together, pool their money and have it managed on their behalf
on a discretionary basis by an investment manager, ie the assets
being managed are not under the day-to-day control of the investors.
19. Funds may be structured as trusts, corporate
vehicles, partnerships or contractual vehicles. They may be "UCITS"
(undertakings for collective investment in transferable securities),
which are the only EU regulated financial product and may be marketed
across Europe to retail investors. The Financial Service Authority
(the FSA) authorises UK funds (both UCITS and non-UCITS) and recognises
EU UCITS and certain other offshore regulated funds (eg Channel
Islands and Isle of Man funds) for sale to UK retail investors.
20. In the business of collective investment
management, use of "offshore financial centres" means
making use of a fund that is legally domiciled offshore. The investors
remain resident in their home territory. The industry comprises
components of activity which could be based in the location of
the fund, the location of the investors, the location of the underlying
asset into which the fund is investing or, indeed, simply where
it is most beneficial to carry out the activity, independent of
all these other factors.
21. A fund will have an operator. This operator
will often be connected to the investment manager, who may, in
turn, delegate part or all of the investment function to investment
managers in other jurisdictions. In addition, fund administration
is typically delegated to specialist third party providers.
22. In particular, UK funds authorised by
the FSA for sale to retail investorsauthorised unit trusts
(AUTs) and open-ended investment companies (OEICs)will
have a fund operator who is specifically authorised by the FSA
for that purpose. There is, also, an independent party who is
responsible for exercising a supervisory role over the fund operator.
This party is either the Depositary (for OEICs) or the Trustee
(for AUTs). It is a company with specific authorisation by the
FSA and its two major roles are custody of the underlying investments
and oversight of the fund operator (a quasi-regulatory role).
23. Beyond these integral components of
the industry, there are the various distribution channels which
are used to bring the product (the fund) to the customer (the
Collective investment and investor motivation
24. Every investor has different objectives,
but common motivations that cause an investor to use a fund rather
than invest directly in the underlying assets are:
access to professional investment
cost-effective access to asset diversification;
cost-effective access to geographical
access to a wider range of asset
liquidity (ie open-ended funds enable
investors to redeem on request at a price based on the net asset
value of the fund).
25. It is not only individuals who use funds.
The assets of institutional investors are often partly or fully
invested in funds. For example, pension schemes are particularly
significant users. Smaller institutional portfolios may make segregated
management uneconomic or, even, unviable; specialised funds are
convenient for those with similar investment goals; market exposure
through index tracking or geographical/asset class diversification
may be more efficiently achieved by pooling, and so on.
III. WHY MIGHT
26. In the past, the UK regulatory regime
has been viewed as unnecessarily restrictive for funds designed
for institutional investors. Also, during the 1990s, after the
first EU UCITS Directive had been adopted, the regulatory regimes
for UCITS in Luxembourg and Dublin were, too, less restrictive.
However, the FSA's fundamental review of its CIS rules in 2003
(which led to the new and widely-welcomed "COLL Sourcebook"),
coupled with increasing scrutiny by and discussion in CESR of
discrepancies between Member States' transpositions and interpretations
of EU legislation, have significantly closed this regulatory gap
between EU fund domiciles.
27. Unfortunately, though, the UK's fund
tax regime is viewed as unattractive by non-UK and certain UK
investors. This continues to drive managers to locate new funds
offshore and, when consolidating fund ranges, to move existing
UK funds offshore.
28. UK authorised funds are subject to a
regime of taxation at fund level. For most UK investors and for
most funds, this system works relatively efficiently, since the
tax at fund level effectively operates as a payment on account
system for investor tax (although see the reference to Stamp Duty
Reserve Tax below). For some investors (generally, UK tax exempt
investors such as pension funds and charities), though, UK funds
with a significant tax charge at fund level are not efficient.
29. In addition, non-UK investors may be
deterred by the fact that UK funds suffer tax at the fund level.
Generally, most tax systems apply tax on most types of investment
income based on the residence of the investor rather than the
origin of the income (although some withholding tax may be levied
by the source country). For foreign investors in UK funds, the
fact that there is a 20% tax charge at the fund level is often
a deterrent to investing in a UK fund, even though in practice
most funds actually pay little if any tax given tax exemption
for UK dividends, tax deduction for interest distributions and
the general ability to offset foreign tax and expenses when computing
tax. Nevertheless, the 20% headline tax rate gives rise to a negative
30. Consequently, UK investment managers
who wish to market fund ranges to non-UK customers tend to make
use of offshore fund ranges (typically in Luxembourg or Ireland),
where there is no tax at fund level. In the interests of economies
of scale, once the decision to establish an offshore range has
been taken, these funds may be marketed within the UK to avoid
the cost of running a second product range purely for UK investors.
31. Another issue which managers must consider
in deciding whether to domicile a fund outside the UK is that
of "trading versus investing". UK authorised funds,
although they pay tax on income, do not pay tax on capital gains.
This is essential to prevent a double layer of taxation for investors.
32. If a manager thinks that there is any
risk that the fund might be subject to a challenge by HMRC that
it is engaged in a financial trading activity (rather than investing,
an activity giving rise to "passive" income and gains),
then any gains treated as capital for accounting purposes would
potentially be subject to tax at fund level as the profits of
a financial trade (ie taxable as income). The risk of a challenge
is generally thought to be small, but the cost of such a challenge
being successful would be commercially ruinous. For this reason,
too, a manager may prefer to domicile a fund outside the UK.
33. It should be noted that where a fund
is distributed into the UK, the manager will wish it to distribute
sufficient income to obtain "distributing fund" status
under the Offshore Fund Regime. Such status, which is in practice
essential if the fund is to be commercially viable in the UK,
avoids what would otherwise be a penal rate of tax for investors
on disposal (ie so that UK investors pay 18% CGT on disposal rather
than income tax at up to 40%). However, this is a consideration
only for UK investors, and offshore funds that do not have to
distribute income are more attractive for many non-UK investors.
34. As well as paying stamp duty reserve
tax (SDRT) on its acquisitions of UK equities, a UK authorised
fund has to pay an additional amount of SDRT based on units purchased
and redeemed in two-week rolling periods. This raises little tax
for the Exchequer (£90 million), but is complex to administer
and audit, is dependent on information provided by third parties
and, with a headline rate of 0.5%, supports non-UK investors'
negative perception of the tax status of UK funds.
35. For these reasons, much institutional
investment is undertaken via offshore funds. Moreover, these offshore
funds are often "transparent" to some degree, for example
contractual funds in Luxembourg or Ireland, or Property Unit Trusts
in Jersey or Guernsey ("J-PUT/G-PUT"). The term transparent
is used to describe an entity that is not itself subject to tax,
but instead tax is levied at the level of its participants. Investors
in transparent funds are effectively treated for tax purposes
as if the underlying assets of the fund were held directly. Transparency
enables an institutional investor to claim Double Tax Treaty benefits
(such as reduced foreign withholding tax on income) based on the
treaty in place between his own home state and the state in which
the asset of the fund is located. A tax-exempt, but non-transparent
fund would generally preclude such a claim by the investor, and
the fund itself, being tax-exempt, would not be able to claim
treaty benefits on its own behalf.
36. Likewise, a UK investor investing in
UK real estate via a J-PUT/G-PUT would be outwith the Non-Resident
Landlord Scheme for UK withholding tax, since the UK investor
would be regarded as investing directly. In addition, for real
estate investment outside the UK, offshore funds may assist in
minimising transfer taxes similar to UK Stamp Duty Land Tax, their
flexible regulatory regime may allow the use of holding companies
to minimise foreign withholding taxes on income, and so forth.
37. Where the investment manager is resident
in the UK, normal corporate (or potentially income) tax rules
apply, and where the investor is resident in the UK, normal investment
income (or corporation) tax rules apply, including (possibly)
the Offshore Funds regime. In other words, as for "mainstream"
offshore funds, the expected application of tax rules to the investment
manager and UK investors is not usurped by the fund's domicile.
38. It is worth mentioning hedge funds for
completeness. The main reason that these are not domiciled in
the UK is that they would, it is widely believed, be regarded
as engaged in a financial trade.
39. While many of these vehicles would be
eligible for authorisation by the FSA as "Qualified Investor
Schemes" (which cannot be marketed to retail investors),
the UK fund tax regime is such that a UK authorised hedge fund
would be tax-disadvantaged. So, the UK is not a hedge fund domicile
in spite of the presence here of many investment managers of hedge
funds. Instead, hedge funds tend to be located in those places
where both the regulatory and tax regimes give the most flexibility,
such as Bermuda or the Cayman Islands.
40. In looking at the various participants,
the following comments may be made on the respective tax positions:
Idustry: investment managers are subject to corporate
profit taxes and employ staff who are subject to payroll taxes.
These taxes are levied generally where the activity occurs (often
the same location as corporate residence). The activity of investment
management (ie asset allocation and stock selection), even for
offshore funds, can quite easily take place in the UK, so is not
directly linked to the location of the fund. However, a number
of activities (for example, fund administration, depositary/trustee
services and the services of professional advisers) tend to occur
where the fund is located, and these activities are generally
taxed, as for other businesses, in the local environment.
Product: UK funds are taxable; Irish and Luxembourg
funds are not. However, since the UK fund tax is creditable for
most UK investors, this is not of itself independent tax revenue,
so does not represent an overall saving of tax by any UK investors.
As regards institutional funds, if transparent, the fund would
not itself be a taxable vehicle, whether onshore or offshore,
since the investor would be taxed as if investing directly.
Investor: UK authorised funds pay out all their
income and UK investors are taxed on this income. Offshore funds
must basically pay out all or a very high proportion of their
income to UK investors or the investors will pay a penal tax rate
on disposal of their investment. Therefore, either way, the use
of tax-exempt offshore funds does not actually represent a tax
saving for retail investors. As noted above, for institutional
investors in transparent funds, the investor is taxed as if owning
the assets directly, so there is no tax differential. Importantly,
UK exempt investors such as pension funds and charities are therefore
left in the correct position if invested in offshore funds, whereas
they may inappropriately pay tax if invested in a UK fund.
41. For the investment management industry,
an "offshore fund centre" commonly means somewhere as
un-exotic as Luxembourg or the Republic of Ireland. Even for non-EU
locations such as the Channel Island or the Isle of Man, offshore
funds may well be used simply for regulatory reasons (eg to facilitate
investment in certain asset classes) or simply for economies of
scale (ie to enable the pooling of assets of different types of
investor in the one vehicle without compromising their appropriate
42. While the tax position for the fund
itself will vary according to location, the investor is generally
taxed similarly regardless of the location of the fund. This is
not the case for some UK investors in UK funds, which makes offshore
funds more attractive. The industry (the investment manager and
other key service providers) will be taxed where the economic
activity of the business is actually conducted. Therefore, the
issue for the UK Government is not abusive tax behaviour using
offshore centres, but the loss of business and employment tax
revenues to the UK due to funds, and hence a number of associated
business functions, being domiciled offshore.
43. A report by IMA/KPMG
found that for every £1 billion of funds domiciled offshore
(which could have been domiciled in the UK), nearly £1 million
a year has been lost to the UK Exchequer. Funds domiciled in Luxembourg
and Ireland with UK investment managers already total twice the
size of UK funds, and the size of the UK funds market continues
to decline relative to these offshore centres. The loss to the
UK Exchequer is therefore mounting.
376 "The Value to the UK Economy of Authorised
Investment Funds", KPMG/IMA, 30 November 2007 Back
Luxembourg 224.5 billion + Ireland 311.1 billion (source-local
trade associations) x 0.2% average local expenses generated by
funds x 36% estimated direct tax rate (CT and employment taxes)
x 0.743 /£ exchange rate. Back
As defined in s235 of the Financial Services and Markets Act 2000. Back
"The Value to the UK Economy of UK-Domiciled Authorised Investment
Funds", KPMG/IMA, 30 November 2007. Back