July 11, 1991
TO: INTERNATIONAL COMMITTEE NO. 13-91
RE: EUROPEAN DEVELOPMENTS IN MUTUAL FUND TAXATION
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This memorandum summarizes recent tax developments in
Europe regarding mutual fund taxation.
1. United Kingdom: U.K. Investment Managers Acting for
Offshore Funds
Proposed legislation in the U.K., Clause 69 of the 1991
Finance Bill (attached), contains two important changes relating
to U.K. investment managers acting for offshore funds. The
Finance Bill is proposed to be effective retroactive to April 1,
1991. Consideration and enactment of the Finance Bill is
expected in July.
The first proposed change provides that a U.K. investment
manager carrying on activities for a number of offshore fund
clients will not be treated as the U.K. taxable agent for an
"unconnected" (defined by reference to common stock ownership)
offshore fund when it performs services such as making investment
decisions and executing trades. This change will permit most
offshore funds to abandon the "echo" system whereby a U.K.
investment manager rendering services to a number of offshore
funds would merely "advise" the offshore fund manager on the
appropriate buy or sell order and the offshore fund manager would
then immediately place the order. However, U.K. investment
managers providing advice to connected foreign investors still
need to take care. In addition, Inland Revenue is likely to
place increased focus on transfer pricing.
Under U.K. law, a fund's gains on its portfolio securities
will not be taxable so long as the fund engages in "capital" or
"investment transactions" rather than "trading" activities. In
the 1990 Finance Act, pension funds and authorized unit trusts
were permitted to treat all trading of options and futures
contracts as "capital". The change proposed by the 1991 Finance
Bill would extend to offshore funds this exemption from having
options and futures transactions treated as "trading". However,
U.K. investment trusts (the corporate, closed-end form of fund)
would still not be covered by any legislative exemption for their
options and futures transactions. Consequently, investment
trusts must still demonstrate that their options and futures
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transactions are not "trading". To assist them in this
determination, Inland Revenue is revising and clarifying the two
Statements of Practice dealing with this issue.
Despite this proposed change, the distinction between
"trading" and "capital" will remain relevant for offshore funds
with U.K. investors because Inland Revenue will not treat an
offshore fund as a "qualifying fund" for purposes of the U.K.
offshore funds legislation (i.e., give the fund "distributor
status") if it is "trading". If an offshore fund loses its
distributor status, its U.K. resident investors would be required
to treat all gain on the disposition of fund shares as ordinary
income, rather than as capital gain eligible for inflation
indexing adjustments and the 5,000 pound annual exclusion for
such gains.
The second proposed change expands the definition of
"investment transactions", which identifies the types of
transactions that U.K. investment managers can execute for
connected offshore funds without subjecting the offshore fund to
U.K. tax, to include options and futures contracts, except those
relating to land.
2. Italy: Capital Gains Tax Reform For Italian Residents
Italy has modified in many respects its taxation of capital
gain, effective January 28, 1991. Italian residents are now
generally taxable on gain on securities held for less than 15
years. In addition, gain is taxable without regard to the period
the securities are held if dispositions of shares by a taxpayer
exceed certain percentages of a company's share capital.
The legislation does not affect investments by U.S. funds
in Italian securities, which remain exempt from capital gains
taxation pursuant to Article 13 of the U.S. - Italian Income Tax
Treaty. It may, however, be necessary for funds selling Italian
securities to notify the broker of the exemption from withholding
in advance of the sale.
Application to Mutual Fund Holdings
Investments in authorized Italian "fondi communi di
investmento" by individual Italian residents remain exempt from
capital gains tax. Also exempt are gains on investments in a
number of Luxembourg-based SICAVs which were authorized for sale
in Italy under the old foreign exchange control legislation,
which expired in mid-1990.
At the present time, it appears that individuals'
investments in other non-Italian UCITS are not exempt from
capital gains tax, although the issue is unclear. In July 1990,
Italy enacted a separate tax of 12.5 percent on the capital gains
of Italian resident individuals' investments in funds located
outside Italy. It is unclear at present whether the July 1990
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system has been superseded by the new rules, so that gains would
now be taxed under the new system at 25 percent, or whether the
old regime still applies. Further legislation may be passed in
the future that will clarify the taxation of gains on other
UCITS.
3. Belgium: New Framework For Investment Funds
Belgium has enacted legislation, effective January 1, 1991,
which generally mirrors the securities and tax treatment provided
for funds by France and Luxembourg. Under the law, Belgium has
two types of investment vehicles -- those with and without legal
personality.
The funds without legal personality are known as FCPs (Fond
Common de Placement), which may be open or closed-ended. Because
an FCP is treated as a collective pool of investments
beneficially owned by the investors, who hold certificates
evidencing their participation, no entity-level tax is imposed on
the FCP's income and gain.
Funds with legal personality may be open-end (SICAVs) or
closed-end (SICAFs). Both SICAVs and SICAFs are, in principle,
liable for corporate tax, but the tax is computed not on profits
but only on certain non-deductible expenses and benefits gained
from non-arm's-length transactions that typically do not arise
merely from investment management. No tax is imposed on SICAVs
or SICAFs with respect to their income and gain, whether these
amounts are retained or distributed to investors. Thus, Belgian
individual investors can now invest in domestic "roll up" bond
funds and so convert taxable income into tax free capital gains.
The legislation also provides other tax rules. First, all
funds (whether FCPs, SICAVs or SICAFs) are exempt from capital
registration duty. In addition, the movable property withholding
tax does not apply to shareholders' redemptions of fund shares.
At present, Belgian funds appear to have one disadvantage
that may limit their attractiveness. Specifically, the
legislation imposes 25 percent withholding on any dividend
distribution from a fund. While the Belgian government has
stated that it intends to exempt nonresidents from the
withholding tax, no such legislation has yet been implemented.
Thus, the withholding tax will apply if a fund distributes,
rather than "rolls up", its income and gains.
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We will keep you informed of developments.
Keith D. Lawson
Associate Counsel - Tax
Attachment