The U.K. tax authority is looking at changing the taxation of derivatives in investment funds, which could sound the death knell to the newly authorized onshore hedge funds, before they even take off. A current Inland Revenue consultation paper proposes a change which would mean investors in these new funds being taxed twice on their capital.
The paper was out for consultation in response to regulatory changes in April that paved the way for onshore hedge funds, dubbed Qualified Investor Schemes (QIS), to borrow 100% of net asset value, to short securities and to use derivatives for investment purposes. The changes would put the U.K. funds market on a par with fund hot spots such as Luxembourg or Dublin, but officials are concerned the Revenue's discussion paper could severely hold back market development.
Before the paper was issued, QIS provisionally followed the same tax guidelines as other authorized investment funds, which are exempt from capital gains tax and pay a lower level of income tax on trading gains. In the paper, the Revenue proposes QIS should be taxed as a company or trust, meaning investors would be taxed twice on their capital.
Hedge fund and traditional managers, such as New Star Asset Management and Premier Asset Management, are all interested in launching funds, but say they can't do this while issues such as tax remain unsolved. Paul Hale, partner at law firm Simmons & Simmons in London, has spoken to several hedge funds interested in setting up qualified investor schemes. "At the moment it's a bit risky to go forward with anything," he said, adding the Revenue's discussion paper does not dispel the uncertainty about the new schemes' taxation. Alistair Nash, tax director at KPMG in London, concurred, "[The discussion paper] makes the tax regime murkier than it was before."
Comments on the paper are due Sept. 24. "The best we can hope is that there will be legislation in next year's budget," said Hale. With a general election due, however, the tax regime for funds is unlikely to be high on the government's agenda, noted one official. There is also concern that proposals for reform of the taxation of investment funds by the Investment Management Association, due on Wednesday, will trigger a wholesale review of the investment funds tax regime, which could mean further delay for any legislation. Officials say the process has already seen significant delays. "[The Revenue's paper] should have been issued a year or so ago," said Nash.
Maddy Ratnett, a spokeswoman for the Inland Revenue, said the proposals in the paper are for discussion and are not settled.
