While the possibility of complete abolition has receded following the election, the non-domiciled regime has not managed to escape unscathed. In his post-election emergency budget, UK chancellor, George Osborne moved swiftly to implement significant reform. Permanent non-dom status is on the way out via the removal of remittance basis of taxation for non-UK-domiciled individuals who have been resident in the UK for more than 15 of the last 20 years. It is far from a complete abolition, but for those non-doms approaching 15 years of residence it might as well be.

At the same time, the rate at which dividends are taxed is set to rise across the board, including for basic rate taxpayers who have never had to pay this levy before. The rises – from 0%, 25% and 30.6% for basic rate, higher rate and additional rate taxpayers to 7.5%, 32.5% and 38.1% respectively – will be effective from April next year, although for those whose portfolio produces less than £5,000 of dividends annually, the new tax-free dividend allowance mitigates this cost.

Given these changes, managers with funds who have not previously applied for entry into the UK’s Reporting Fund Regime – first introduced in 2009 – may wish to reconsider. The Reporting regime is designed to make funds more attractive to UK investors, and the reform of the non-dom status combined with dividend tax hikes could mean a surge in demand from residents looking to revisit their arrangements.

28% capital gains tax versus 45% income tax
Broadly, a fund that is compliant with the UK’s Reporting Fund Regime can enable certain UK investors to be taxed on their gains from redemption at capital gains tax rates (currently, 18% for basic rate tax payers and 28% for higher rate tax payers) as opposed to income tax rates (currently 20% for basic rate tax payers, 40% for higher rate tax payers, and 45% for additional tax rate payers).

For those investors who have not utilised their capital gains annual exemption (currently £11,100) the effective rate of tax on these gains would be further reduced. If planned correctly, it may even be possible for a married couple/civil partnership couple to utilise both of their annual exemptions (potentially giving rise to gains of up to £22,200 as being tax free).

Investors who hold shares in a Reporting Fund (except for bond funds, i.e., mainly invested in interest-bearing assets) are subject to income tax at the new dividend tax rates mentioned above on their share of the fund’s undistributed income (“Reportable Income”). While this is an acceleration of part of the tax for the investor if there has been no disposal of their interest in the fund, the potential benefits could outweigh this acceleration. The combination of the £5,000 dividend allowance plus the additional benefit that gains on redemption of shares in a fund would be taxed at the lower capital gains tax rates, or could be covered by the Annual Exemption, could well result in a significant tax benefit to investors.

It is also worth remembering that the reportable income that has been previously taxed is available for relief against proceeds on redemption – thereby eliminating any “double taxation” on any part of the total return.

We have also seen more funds that are actually distributing most of their income (another reason why the dividend allowance is helpful) and so for these funds, the amount of reportable income would be insubstantial, as distributed income is already subject to UK income tax.

Giving investors a choice
Offering flexibility is always attractive for many investors and one of the highlights of this regime is that a share class is effectively treated as a fund in its own right. So if a fund has a group of UK-resident investors that prefer not to hold an interest in a reporting fund, then the fund can issue a class of shares that is within the regime and one class that is not. Fund managers, therefore, have the flexibility of offering both options to its UK investors. This enables investors to consider which option suits them (e.g., an individual who thinks he may leave the UK and therefore become non-UK-resident for tax purposes, may prefer to own shares in a non-reporting fund).

When calculating reportable income, capital profits arising from a sale of assets by the fund are excluded from the calculation, as are unrealised investment gains on the assets still held by the fund.

Conclusion
The key driver for this decision is the manager’s desire to make its fund products more appealing to UK investors. All managers should think about whether the Regime represents an opportunity for its investors to enhance the fund’s competitive edge in terms of post-tax return to investors, especially in light of recent developments regarding the UK’s non-dom status, and dividend tax hikes.