Annex 1: Minor Changes in the Law Change 60: Relationships treated as loan relationships etc: meaning of offshore funds for qualifying investments test: sections 489 and 587
This change clarifies the meaning of “offshore fund” in paragraphs 4 and 8 of Schedule 10 to FA 1996 for the purposes of the “non-qualifying investments test” (known as the “qualifying investments test” in Part 6 of this Act (relationships treated as loan relationships etc)).
Paragraph 4 of Schedule 10 to FA 1996 provides for a company’s “relevant interests in an offshore fund” to be treated as a right under a creditor relationship where the fund fails to satisfy the non-qualifying investments test: broadly where more than 60% of the holdings of the fund by value represent investments that would be loan relationships if held directly by the company.
“Offshore fund” is not directly defined for the purposes of paragraph 4 of Schedule 10 to FA 1996, but the meaning of “relevant interest in an offshore fund” for the purposes of paragraph 4 is given by paragraph 7 of the same Schedule. It is defined as a material interest in an offshore fund for the purposes of Chapter 5 of Part 17 of ICTA or an interest which would be such an interest on the assumption that the unit trust schemes and arrangements referred to in section 756A(1)(b) and (c) of ICTA were not limited to collective investment schemes. Section 756A(1) of ICTA (which is subject to sections 756B and 756C of that Act), gives the meaning of “offshore fund” for the purposes of Chapter 5 of Part 17 of ICTA and requires that offshore funds should be collective investment schemes. But the definition of “relevant interest in an offshore fund” in paragraph 7 extends that meaning.
The “non-qualifying investments test” referred to in paragraph 4(1) is in paragraph 8 of Schedule 10 to FA 1996. Paragraph 8(7F) requires “offshore fund”, for the purpose of the test, to have the same meaning as in Chapter 5 of Part 17 of ICTA, but it does not mention the assumption in paragraph 7(1)(b) of Schedule 10 that unit trust schemes and arrangements referred to in section 756A(1)(b) and (c) of ICTA need not be limited to collective investment schemes. So it is unclear if that extension to non-collective investment schemes applies.
The definition in paragraph 8(7F) applies to offshore funds held by the investing company, that is, the same offshore fund and the same company as are referred to in paragraph 4(1) (to which the definition in paragraph 7 refers) since the definition in paragraph 8(7F) also applies for the interpretation of “assets of an offshore fund”. That expression occurs in paragraph 8(5)(b), which in turn gives the meaning of “investments of an offshore fund” for the purposes of paragraph 8(1) (“investments of the … fund”). This is the same offshore fund referred to in paragraph 4(1).
Paragraph 7(1)(b) and (2) of Schedule 10 provides that for the purposes of paragraph 4 of Schedule 10 an interest is a “relevant interest in an offshore fund” (and therefore falls within paragraph 4(1)(a)) if it would be a “material interest in an offshore fund” assuming the arrangements in section 756A(1)(b) and (c) of ICTA were not limited to collective investment schemes. Therefore it appears that the clear legislative intent is that such interests are subject to paragraph 4 if the fund “fails to satisfy the non-qualifying investments test” in paragraph 4(1)(b), so that the debits and credits brought into account for the purposes of corporation tax as respects the company’s interest in the fund are determined on the basis of fair value accounting.
If, when FA 2004 added paragraph 8(7F) to Schedule 10, the intention had been that the narrow definition in paragraph 8(7F) was to apply without the extension implied by paragraph 7(1)(b) and (2) and so that extension was to be ineffective, FA 2004 would have repealed paragraph 7(1)(b) and (2), and there would have been mention of this intention in the commentary on the Finance Bill 2004. So it appears that the better interpretation is that the wider definition of an offshore fund given by the application of the assumption in paragraph 7(2) was meant to apply throughout and therefore it is applied by section 489 for the whole of Chapter 3 of Part 6 of this Act and the definition of assets of an offshore fund in section 493 is glossed accordingly.
Section 587 in Part 7 of this Act (derivative contracts) refers also to a holding that is “a material interest in an offshore fund” and applies the meaning of that phrase in section 489. This change therefore applies also for the purposes of that section.
This is a minor change in the law as it will prevent the taxpayer from arguing the contrary view that the assumption in paragraph 7(2) does not apply.
Adopting the wider definition of what is an offshore fund potentially brings more investments within the possibility of being qualifying investments and therefore makes it more probable that holdings in the unit trust or offshore fund with the investments are subject to the loan relationship provisions. Whether being subject to the loan relationship provisions is adverse or beneficial depends on the circumstances of the taxpayer.
This change is in principle adverse to some taxpayers and favourable to others. But it is in line with the original legislation before amendment and with the intention of the amended legislation.