742 Offshore funds operating equalisation arrangements

Summary

This section applies the provisions of the Chapter to offshore funds which are 85 per cent distributing funds where those funds operate equalisation arrangements.

A fund operating equalisation arrangements pays to an investor who redeems his/her investment the amount of the dividend accruing to him/her up to the date of the redemption of the investment as part of the overall redemption payment. If the investor who leaves is replaced by a new investor, the fund will have paid out part of the distribution, due to be paid to that new investor, to the departing investor as part of the redemption proceeds. Accordingly, unless the new investor makes a payment to the fund, when he/she first invests in the fund, to replace the part of the distribution paid out to his/her predecessor, he/she will not get the full distribution of income or dividend when it is paid by the fund. Funds operating equalisation arrangements are able to pay an equal distribution of income or dividend in respect of all shares or investments units by requiring new investors to pay for the part of the distribution accruing to the date of their investment in the fund. The new investors make the required payments into the equalisation account of the fund. Therefore, part of the first distribution or dividend the new investor receives from the fund cannot be regarded as income of the investor. It is merely a refund of the investor’s payment into the equalisation account. The equalisation account, as the name suggests, enables the fund to pay an equal dividend to all investors irrespective of the date of their investment.

For the sake of consistency, the Chapter charges as income the part of redemption proceeds in respect of an interest in a fund operating equalisation arrangements which represents the distribution or dividend accruing to the date of redemption.

For the purposes of the 85 per cent distribution test, the 2 investors are treated as having shared a full distribution or dividend between them (see paragraph 2 of Schedule 19).

A number of special provisions are necessary to adapt the offshore fund legislation in respect of funds which operate “equalisation arrangements”. The significance of a fund operating equalisation arrangements lies in the nature of the payments which investors receive on the occasion of a distribution and on the occasion of redemption of their interest. When an investor receives his/her first distribution after acquiring the interest, part of that sum is treated as capital. It is this point – the treatment of the distribution as capital in the shareholder’s hands – which would make it difficult for a fund operating equalisation arrangements to satisfy the distributor test, which requires distributions in the form of income. The primary aim of the special rules is, therefore, to enable such funds to obtain distributor status. This aim is achieved by treating the equalisation element in the redemption proceeds as income. The fund is thus enabled to meet the distributor test; however, the corollary is that the investor is charged to income tax on a sum which would otherwise have been capital. By this means a measure of consistency is achieved as between funds operating equalisation arrangements and other offshore funds.

It should be noted that this special treatment of equalisation funds applies only to funds which meet, in all other respects, the conditions for exemption as distributing funds, and have met them since the investor acquired his/her interest (or since 6 April, 1990, if later). It only applies to disposals on or after 6 April, 1990 and does not apply to a disposal if the proceeds are taken into account as a trading receipt.

Details

(1) Equalisation arrangements are defined as arrangements which have the result that where —

• an investor acquires (by subscription, allotment, or otherwise directly from the fund managers) a “material interest” in the fund, and
• the fund makes a distribution for a period beginning before the investor’s acquisition of his/her interest,

the amount of that distribution which is paid to him/her includes a capital element which is debited to an equalisation account (maintained specifically for the purposes of such arrangements) and which is calculated as the part of the distribution which has accrued before the investor acquired his/her interest. The capital element of the distribution which is debited to the equalisation account matches that part of the payment made by the investor on acquiring the interest which would have been credited to the equalisation account.

(2) Acquisition is defined by “initial purchase”. Equalisation arrangements would not be a feature of purchases other than transactions involving the fund or the managers of the fund in their capacity as such.

(3) The charge under the Chapter is extended to disposals of material interests in funds which are 85 per cent distributing funds but which operate equalisation arrangements. The provision does not apply to trading transactions since the profits from such transactions would be charged as income apart from the provisions of the Chapter.

(4) Where investors would be treated as chargeable in respect of the income (as income from a foreign possession) of an offshore fund as it accrued to the fund, the investors will not also be charged under the provisions of the Chapter as applied to funds operating equalisation arrangements.

(5) & (6) Certain reorganisations, take-overs, reconstructions and amalgamations of companies which involve exchanges of shares are treated as giving rise to disposals of the original shares for the purposes of determining whether the offshore fund provisions are to be applied to a disposal of an interest in a fund which is a distributing fund but which is operating equalisation arrangements.

Relevant Date: Finance Act 2021