United Kingdom Taxation

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1 United Kingdom Taxation FUNDS AND FUND MANAGEMENT Taxation of funds Authorized open-ended mutual funds in the United Kingdom are organized as authorized unit trusts (AUTs) or open-ended investment companies (OEICs) - these are collectively termed authorized investment funds. In addition, the regulatory regime distinguishes between three types of authorized investment fund: UCITS, non-ucits retail schemes, and qualified investor schemes (QIS). OEICs and AUTs, be they UCITS, non-ucits retail schemes or QIS, are taxed in the same way (although there are some restrictions imposed on QIS) so the rest of this section refers to the taxation of authorized investment funds. Openended mutual funds may also take the form of unauthorized unit trusts. The taxation of unauthorized unit trusts, which cannot be UCITS funds, are not considered further for the purposes of this survey. In recent years, to make UK authorized funds more competitive, a number of new tax regimes have appeared to provide tax efficient return for certain investors or certain asset types. Open-ended investment companies and authorized unit trusts (authorized investment funds) Authorized investment funds are taxed according to the same rules as other UK companies, apart from the fact that they are exempt from tax on capital gains and are subject to a lower rate of corporation tax (currently 20 percent). They must distribute all their income net of expenses, and are deemed to distribute all of their income after deduction of expenses and tax regardless of whether the income is paid out as cash or accumulated within the fund. Income cannot therefore be rolled up tax free within the fund.

2 2 United Kingdom Taxation Bond funds and interest distributions A fund which holds over 60 percent of its assets in interest yielding assets can make an interest distribution. The interest distribution is tax deductible, so, after deducting the interest distribution from the fund s net income, these funds do not normally have any residual taxable income and consequently have no corporation tax liability. Generally, on payment of an interest distribution there is a requirement to deduct income tax (currently 20 percent) at source. However, interest should be paid gross to the following: Companies and unit trusts Certain tax exempt investors including pension funds, charities, and PEP/ISA holders Non-resident individuals An interest distribution can be paid gross to a non-resident investor if the investor provides a declaration that they are non-resident or invests via a reputable intermediary and the manager has reason to believe that they are non-resident. UK bond funds can therefore be tax efficient for non-uk investors and those UK investors able to receive interest gross. Non-bond funds and dividend distributions Distributions paid by funds that are not bond funds are not deductible for tax purposes, and are treated as UK dividend income in the hands of recipients. Dividends received from UK companies by authorized investment funds are not subject to corporation tax in the fund. Therefore, UK equity funds, which derive almost all of their income from UK companies, do not suffer corporation tax on their income as the tax deductible expenses of management usually exceed the taxable income. Overseas equity funds will derive a significant part, if not all of their income, from overseas dividends which are now generally exempt from UK tax, unless an election is made to tax them. Where such an election is made, it should be possible to offset any overseas withholding tax incurred against the fund s corporation tax liability. This will often result in little or no UK corporation tax being payable.

3 3 United Kingdom Taxation Overseas tax Authorized investment funds are generally entitled to take advantage of the treaty rates applicable to withholding taxes under the UK s numerous (over 100) double tax agreements (see section 3.7). Special regimes QIS Until 1 January 2009, certain categories of investor in a QIS who held 10 percent or more of the QIS (whether alone or together with associates or connected persons) were broadly taxed on the fair value movement of their investment as income. With effect from 1 January 2009, the 10-percent test has been replaced by a genuine diversity of ownership test. This test is broadly met if the fund is made widely available and is not limited to a specific person or specific group of connected persons. Property authorized investment funds The property authorized investment fund (PAIF) tax regime was introduces on 6 April A PAIF s investment portfolio must comprise predominantly of real property or shares in UK REITs and similar entities. A PAIF will not be subject to tax on income which is derived from its ringfenced property investment business. In principle, it is subject to corporation tax on its residual net income at 20 percent, although in practice tax should not apply where an interest distribution is made out of this income. UK dividend income and capital gains are not taxed in the PAIF. In order to be eligible to enter the PAIF regime, the following conditions must be satisfied throughout each accounting period: Property investment business: Its investment portfolio comprises predominantly one or more of the following activities: o o o A property rental business which is defined as a schedule A buisness or an overseas property buisness real property Shares in UK-REITs Shares in certain foreign entities equivalent to UK-REITs Genuine diversity of ownership condition (See QIS in Section 3.3)

4 4 United Kingdom Taxation Corporate ownership condition: The PAIF must prohibit any corporate investor from holding more than a 10 percent beneficial entitlement of the assets of the PAIF and it must take reasonable steps to ensure compliance with this condition Loan creditor condition: The terms of any loan to which the PAIF is a debtor must be on normal commercial terms. Balance of business condition: At least 60 percent of the PAIF s net income should be derived from its property investment business and at least 60 percent of its assets should be invested in that business. This limit is reduced to 40 percent in the first accounting period for newly qualified funds. There is no entry charge for AIFs electing into the regime. Distributions made by a PAIF must be split into the following three pools: Property income distributions (PIDs, taxed as the profits of a schedule A or UK property business) Interest distributions Dividend distributions Individuals will received PIDs and interest distributions under deduction of tax (at 20 percent). Tax exempt investors can reclaim the tax deducted. Dividends are treated in the same manner as the receipt of any other UK company dividend. Distributions made to investors who are subject to corporation tax are not generally subject to any deduction of tax by the PAIF. Tax elected funds (TEF) Under the new tax elected fund (TEF) regime, UK AIFs that meet certain conditions can elect to be treated as a TEF. TEFs are required to make two types of distribution of the income they receive - a dividend and a non dividend (interest) distribution. UK dividend income will remain non taxable in the fund and will be distributed as a dividend. For all other income that is distributed as a non-dividend (interest) distribution, the fund will receive a tax deduction up to the same amount. This measure moves the point of taxation from the AIF to the investor so that the investor is treated as though they had invested in the underlying assets directly. UK investors are treated as receiving UK dividend income (including the non payable dividend tax credit) and a payment of yearly interest.

5 5 United Kingdom Taxation The other conditions to qualify as a TEF are as follows: The fund should not have a UK property business or an overseas property business; Where the fund is a debtor in a loan relationship, the interest should not be dependent on the result of fund's business or value of fund's assets, should be at arm's length or should not exceed the consideration lent; The instrument constituting the fund and the prospectus should include provisions that require the fund to meet the first and second conditions above; and The fund meets the genuine diversity of ownership condition. This broadly means that the following tests should be met: o The fund documents contain a statement that units in the fund will be widely available, specify the intended categories of the investors and specify that the fund manager must market and make available the units in the fund in accordance with the third condition below; o Neither the specification of the intended categories of investor, nor any other terms or conditions governing participation in the fund, whether or not specified in the fund documents, limits investors to a limited number of specific persons or specific groups of connected persons or deters a reasonable investor within the intended categories of investor from investing in the fund; o Units in the fund must be marketed and made available sufficiently widely to reach the intended investors and the intended investor can obtain the information about the fund and acquire units in it. Diversely Owned AIFs (DOAIFs) This legislation has been introduced to clarify whether certain transactions carried out by AIFs and equivalent offshore funds would be taxed as trading or investment. The DOAIF regime came into effect from 1 September 2009 and provides that where a fund carries out investment transactions (as defined in the DOAIF regulations) and meets the genuine diversity of ownership condition (see above), any capital profits or losses arising on those transactions would not be subject to tax as trade profits. Capital profits, gains or losses arising from an investment transaction in an accounting period are such profits, gains or losses as fall to be dealt with under

6 6 United Kingdom Taxation the heading net capital gains/losses in the statement of total return for an accounting period. An investment transaction is defined as: any transaction in stocks and shares; any transaction in an option, future or contract for differences; any transaction which results in a diversely owned AIF becoming a party to a loan relationship or a related transaction in respect of a loan relationship; any transaction in units in a collective investment scheme; any transaction in securities; any transaction consisting in the buying or selling of any foreign currency; any transaction in a carbon emission trading product. Ongoing consultations and proposals HM Treasury is considering further proposals to make the UK an attractive fund domicile. The main proposals are as follows: Funds Investing in Non-Reporting Offshore Funds (FINROFs) The current tax rules are not suitable for funds that hold units in offshore funds that do not have distributor or reporting status (see below). Therefore, it is proposed to introduce a new tax regime for such funds. This regime will apply to funds that invest more than 20 percent of their gross assets in non-reporting funds or other FINROFs. The framework is elective. For FINROFs that elect into the new regime, the point of tax will move from the fund to the investor, with the result that the UK investors should face similar tax treatment as they would have had they invested into the underlying non-reporting offshore funds directly. Such a FINROF would not be subject to tax on gains on disposal of assets. However, tax-paying UK-resident investors in an elected FINROF would be liable to income tax (rather than capital gains tax) on realization of their interest in the FINROF. The regulations are currently in the draft form and it is currently proposed that the regime will come into force from 6 March 2010.

7 7 United Kingdom Taxation 3.2 Taxation of resident investors in a UK fund Capital gains Individual investors in an authorized investment fund are taxed on capital gains realized on the disposal of shares/units in an authorized investment fund at 18 percent. A tax liability will only arise if the investor s gains are more than the annual exemption, which is GBP 10,100 for the fiscal year 2008/09 (GBP 9,600: 2008/09). Corporate investors are taxed on capital gains realized on disposal of shares/units in funds other than bond funds at the applicable rate of corporation tax, subject to certain reliefs. Corporate investors are required to tax the fair value movement of their investment in a bond fund. Income: bond funds Bond fund distributions are taxed as interest and the 20 percent tax deducted at source can be offset against the investor s tax liability or, where it exceeds that liability, the excess can be recovered. Corporate investors in bond funds are taxed on realized and unrealized gains and the income from the fund at the relevant rate of corporation tax (generally 28 percent). Income: non-bond funds Dividend distributions carry a tax credit of one-ninth of the net dividend (10 percent of the gross). They are taxable in the hands of individual investors, but are treated differently in the hands of corporates. The tax credit is not recoverable by non-tax payers. The rate of tax on dividends is 10 percent for starting rate tax payers, who will have no further tax to pay as the tax credit is deemed to satisfy their tax liability. Higher rate tax payers pay tax at 32.5 percent on their gross dividend income, but can set off the 10 percent tax credit against their tax liability (this results in higher rate tax payers paying tax at 25 percent of the net dividend). From 6 April 2010, individuals with annual income of more than GBP 150,000 will be subject to 42.5 percent tax on the dividend income, but can set off the 10-percent tax credit against their liability (this results in highest rate tax payers, paying tax at percent of the net dividend). Dividend distributions paid to corporate investors are streamed into UK dividend income (non-taxable) and other income (taxable) according to the proportions of underlying income received by the authorized investment fund

8 8 United Kingdom Taxation making the distribution. The proportion of the distribution treated as taxable income is deemed to have suffered income tax at 20 percent, and corporate investors can set this off against their corporation tax liability. If they do not have a tax liability, they can reclaim the tax credit applicable to the distribution received, provided the fund has itself paid a proportionate amount of corporation tax to the HM Revenue and Customs. 3.3 Taxation of resident investors in a non-resident fund The taxation of a UK investor in a non-resident fund will, in general, depend upon the legal nature of the offshore collective investment scheme in question. Non-resident funds tend to fall into three categories: funds that are fiscally transparent in respect of both income and gains (such as contractual funds and limited partnerships); funds that are transparent for income but not gains (such as some unit trusts); and funds that are transparent for neither income nor gains (for example SICAVs). Fiscally transparent funds Funds with no separate legal identity, where investors are beneficially entitled to income and gains on an accrual basis, are transparent for UK tax purposes. The fund s investors therefore pay tax on their share of the fund s income and gains regardless of whether these are distributed. Where overseas income arising from the underlying investments of the fund has suffered local withholding tax, it is possible for investors to claim double tax relief in respect of this income. In practice, where there are many investors and many investments the application of double tax treaties is difficult to operate because of the numerous combinations that could apply. This is a particular difficulty for vehicles such as FCPs. In Finance Act 2009, HMRC announced that an interest in a transparent offshore fund that satisfies the new definition of an offshore fund would be treated as an asset for capital gains tax purposes. Partnerships are not affected. This treatment applies to investments made on or after 1 December 2009 but investors may make an irrevocable election for the new treatment to apply retrospectively from the tax year This change is currently relevant only for individual investors but similar changes for corporate investors are being considered. Unit trust schemes Some offshore unit trusts fall between being fiscally transparent and being corporations. The general law position usually means an offshore unit trust is

9 9 United Kingdom Taxation transparent for income purposes but there is specific UK tax legislation deeming them to be companies for capital gains tax purposes. UK resident investors are generally taxed on income as it arises, but capital gains of such a fund will only be taxable when the investment in the unit trust is realized (but see below for how gains are taxed). Non-transparent funds UK investors will be taxed on distributions received from the fund as income and on capital gains realized on disposal of shares in the fund at the applicable rate, subject to the effect of the offshore funds legislation (see below). A 10- percent tax credit is available on overseas dividends in the same way as for UK funds. Distributions made by offshore bond funds on or after 22 April 2009 are treated as interest distributions. Offshore funds legislation This legislation sets out the detailed rules for taxation of gains from nonresident funds. There are two categories of offshore funds: those which are certified as distributing or reporting funds and those which are not ('nonqualifying funds'). Gains on disposal of holdings in non-qualifying funds are taxed as income rather than capital gains. This stops individuals in particular benefiting from the 18- percent rate on capital gains tax and potentially imposes a tax liability on investors with an exemption from capital gains tax (that is, authorized investment funds, and investment trust companies). Income that is distributed by such a fund is also taxed as income when received. In order to be certified as a distributing fund, an offshore fund is required to demonstrate to HMRC that it has distributed at least 85 percent of its UK equivalent profits. Also, the fund seeking the distributor status should not invest more than 5 percent of its assets in other non-qualifying funds. This procedure must be undertaken annually. Separate sub-funds and share classes can apply for distributing or reporting status in their own right. The income reported by a certified fund is taxed as income in the hands of the investors and gains on realization of the investment are taxed as capital gains. To be certified as a reporting fund, offshore funds are required to report their income to the investors as well as to HMRC. There is no distribution requirement and there are new rules for funds of funds to replace the above 5 percent test. The other major change in that funds must apply up-front to enter the regime. The income reported by a certified fund is taxed as income in the hands of the investors and gains on realization of the investment are taxed as capital gains.

10 10 United Kingdom Taxation The reporting fund regime is effective from 1 December Offshore funds may apply for reporting fund status for periods of account commencing on or after 1 December However, funds currently certified as distributing funds may apply to HMRC to be treated as distributing funds for the period from 1 December 2009 until the end of their period of account. Provided the fund is granted distributor status for this period, it may then apply to HMRC to continue to be treated as a distributing fund for the next period of account. The reporting regime then applies to the following period. Controlled Foreign Companies Legislation The UK controlled foreign company (CFC) legislation may apply where a company is resident in a jurisdiction in which its profits are effectively taxed at a rate which is less than three-quarters of the corresponding UK corporation tax rate (28 percent). If more than 50 percent of an offshore fund that constitutes a CFC is controlled by UK resident investors, and any UK resident company, either alone, or together with connected persons, controls 25 percent or more of the fund, that UK company may be assessed to corporation tax in respect of its attributable share of the profits of the fund excluding capital gains. A company is also regarded as if it was controlled by persons resident in the UK if: two persons, taken together, have control; each of the two persons has at least a 40-percent share; and one of them is resident in the United Kingdom. Such an assessment may not be raised if the fund pursues an acceptable distribution policy, that is, distributes annually 90 percent of its profits for the period as calculated for tax purposes. It is currently proposed that this exemption be phased out in one year's time with the introduction of the foreign dividend exemption. In such a case, the profits of the CFC will be apportioned to the UK investor unless it falls into any of the other exemptions (such as the motive test exemption) 3.4 Taxation of non-resident investors in a resident fund Non-resident shareholders are not liable to capital gains tax in the UK on disposals of their shares/units in an authorized investment fund unless the shares are connected with a branch or permanent establishment of the shareholder in the United Kingdom. As noted in Section 3.2 above, dividend distributions carry a tax credit of oneninth of the net dividend (10 percent of the gross). Non-residents may be able

11 11 United Kingdom Taxation to recover part of this tax credit under the terms of the double tax agreement between their country of residence and the United Kingdom. There is no withholding tax on dividend distributions paid to non-residents. Interest distributions to non-residents may be made gross if the investor provides a declaration of non-residence or invests via a reputable intermediary (see Section 3.1). If an interest distribution is made net of income tax at 20 percent, the tax may be recoverable under the terms of the relevant double tax treaty. Authorized investment funds are obliged to report payments of interest (and certain other payments which comprise an element of interest) to certain nonresident investors to the UK tax authorities. This information may only be exchanged with countries with which the UK has concluded an agreement to do so. It should be noted that the EU Savings Directive was implemented in the UK from 1 July 2005 the UK has elected to report under the Directive rather than withhold tax. 3.5 Taxation of fund management/custodian companies There are no special incentives in the UK for such companies, and they are taxed according to general corporate tax rules. The rate of corporation tax in the UK is generally 28 percent. 3.6 Entitlement to Income Income arises to the investor when it is distributed by the fund. As detailed above, OEICs and authorized unit trusts are deemed to distribute all of their net income after tax even if accumulated within the fund. 3.7 Double tax agreements Whether or not a fund resident in a state with which the UK has a double tax agreement is entitled to the benefit of that agreement depends both on the nature of the fund vehicle, and on the agreement in question. For example, HM Revenue and Customs is not normally prepared to accord treaty benefits to fiscally transparent entities such as FCPs, although an investor in an FCP may, in theory, be entitled to claim treaty benefits if resident in a country which has a suitably worded double tax agreement with the United Kingdom. The UK is party to more than 100 double tax agreements. This extensive treaty network means that UK funds investing in countries with high levels of withholding tax may provide a higher post-tax return for investors if they are domiciled in the UK, compared to funds domiciled in countries which offer an exemption from tax for investment funds but have access to a limited number of double tax treaties.

12 12 United Kingdom Taxation 3.8 Other tax-favored vehicles Investment trusts Investment trusts are closed-ended companies that are exempt from UK tax on their capital gains for each accounting period in which they meet the necessary requirements. In order to qualify as an investment trust company, the company must distribute most of its income to its shareholders each year; most of its income (at least 70 percent) must be derived from shares or securities, and it must comply with certain investment spreading rules. Realized and unrealized gains cannot be distributed. The company cannot be a close company and must be UK resident and listed on the London Stock Exchange. As it is closed-ended, an investment trust cannot qualify as a UCITS. An elective regime for investment trusts has been introduced to allow them to invest tax efficiently in interest bearing assets by streaming interest income. As set out in the framework, the interest income will remain taxable in the investment trust. The interest distribution will then be deductible from corporation tax when paid to shareholders as an interest distribution. Venture capital trusts Venture capital trusts are closed-ended companies that benefit from the same tax reliefs as investment trusts. They must meet conditions similar to those that apply to investment trusts (that is, they must distribute most of their income to their shareholders, most of their income must be derived from shares and securities, they must comply with investment spreading rules, they cannot be close companies and must be listed on the London Stock Exchange) but are also required to satisfy stringent tests regarding their investment portfolio. Venture capital trusts essentially must invest in small trading companies. A venture capital trust is not prohibited from distributing its gains but again as it is closed-ended, it cannot qualify as a UCITS. Individuals who invest in a venture capital trust can also obtain tax relief in respect of their investment and the disposal of their investment. Dividends paid by a VCT do not represent taxable income.

13 13 United Kingdom Taxation Real estate investment trusts Real estate investment trusts were introduced in the United Kingdom from 1 January They are also closed-ended companies (and therefore cannot qualify as a UCITS), must be listed on a recognized stock exchange and cannot be a close company. Real estate investment trusts, providing certain conditions are satisfied, pay no tax on their rental income or gains realized on the disposal of their investment properties. In order to qualify for these tax advantages the following conditions must be met: The company must be UK tax resident. The company must invest in at least three properties. No one property can represent more than 40 percent of the company s total portfolio. At least 90 percent of the rental income must be distributed to the shareholders. At least 75 percent of the company s profits must be derived from the rental business (and 75 percent of the company s assets must be engaged in that business). Property that is owned and occupied by the company or another group company (such as a hotel business) is excluded from the property rental part of the business. The company may only issue one class of ordinary shares and the only other class of shares it may issue is non-voting fixed rate preference shares. The company may not be a party to a loan relationship which is on noncommercial terms, provides a rate of interest which is linked to the results of the company, or provides for repayment of capital on non-commercial terms. Existing companies wishing to become a real estate investment trust must pay an entry charge equal to 2 percent of the market value of their assets. A distribution made by a real estate investment trust in respect of its rental business will constitute rental income in the hands of the shareholder. The real estate investment trust must withhold tax at 20 percent from any distributions paid out of the rental business profits. However, certain shareholders are entitled to gross payment including the following: Companies resident in the United Kingdom for corporation tax purposes

14 14 United Kingdom Taxation Certain tax exempt investors including pension funds, charities, and PEP/ISA holders A tax charge can be imposed where a dividend is paid to a corporate investor who holds a shareholding of 10 percent or more in a real estate investment trust, or where the quantum of the trust s financing costs causes its interest cover ratio to fall below 1.25: Transfer taxes, stamp duty, capital duty Transfers of shares in UK companies (including investment trust companies) are generally charged to stamp duty reserve tax (SDRT) at 0.5 percent of the price paid. The taxpayer for this charge is the transferee. New issues of shares are not chargeable. However, shares in OEICs and units in authorized unit trusts are subject to a special SDRT regime that charges a fund in respect of surrenders of its shares/units. The headline rate is 0.5 percent of the value of shares/units surrendered but this is reduced, often substantially, by two formulae in the tax rules. First, the charge is reduced if, and to the extent that, the total number of shares/units issued is lower than the total number surrendered in a two-week period (issue surrender multiplier). Second, the proportion of the fund s assets that are exempt bonds and non-uk shares further reduces the SDRT. HM Revenue and Customs is currently consulting on the reforms to this special SDRT regime. In this regard, the HM Revenue and Customs has suggested two options. The first one relates to a new asset-based tax that would be levied on the average daily net asset value. The second option relates to removal of issue-surrender multiplier from the calculation and to calculate the tax on annual value of surrenders instead. It is also proposed that under the second option, any investment by a fund in other collective investment schemes would be an exempt investment. The welcome change under both options is that now an annual calculation and an annual return would be required instead of fortnightly/monthly calculations and returns. A unit trust dedicated to investment in a property AIF is exempt from SDRT Value-added tax (VAT) Management services rendered to special investment funds are exempt from VAT. UK legislation originally treated only OEICs and authorized unit trust schemes as special investment funds; however the ECJ decision in the case of AIC/JP Morgan Claverhouse (released in June 2007) suggested that investment trust companies should qualify as special investment funds and benefit from the VAT exemption. Thus, the UK domestic law was changed with effect from 1 October 2008 to comply with the judgment and extend the investment

15 15 United Kingdom Taxation management VAT exemption to investment trust companies (ITCs), venture capital trusts (VCTs), and certain overseas funds and sub-funds which are made available to UK retail investors and regulated under the FSMA As a result of these changes, managers are no longer able to recover VAT on costs in connection with the provision of investment management services to qualifying overseas funds or sub-funds. The liability of the services remains outside the scope of UK VAT. HMRC have introduced certain concessions in respect of this latter change and have confirmed that: One overseas sub-fund falling within the scope of the revised exemption will not taint the VAT recovery in respect of the whole management fee to the umbrella fund; The fund/sub-fund must be actively marketed to UK investors; If the fund/sub-fund is not being actively marketed to UK investors and there has been a take-up of shares/units of less than 5 percent by UK investors, then this is treated as de minimis and VAT recovery can continue to be made in full; and Managers can apportion their restricted input tax on a sub-fund by sub-fund basis on a fair and reasonable basis. The above provisions in respect of qualifying overseas funds will also apply to sub-delegated fund management services. The definition of management services was considered by the ECJ in the Abbey case in It was held that the services of trustees or depositories are not covered by the concept of management but fund accounting and administration services would qualify as management services provided they were distinct fund administration services, specific to and essential for the management of the authorized investment fund. Therefore outsourced fund administration services provided to managers also benefit from the exemption in respect of Special Investment Funds EU/EEA law claims Following cases heard in the European Courts (for example, Fokus Bank case (Case E-1/04), Denkavit (C-170/05) and Verkooijen (C-35/98)), there are a number of potential claims to be made by investment funds in the United Kingdom. The main ones are outlined below.

16 16 United Kingdom Taxation Dividend withholding tax claims Following the Fokus Bank case, investment funds which have suffered withholding tax on dividend income from EU and EEA countries can make a claim to the appropriate overseas tax authorities for that tax to be repaid to the fund, on the basis that the withholding tax was in breach of EU and EEA law allowing the free movement of capital. Funds should consider the impact of making a withholding tax claim on the UK tax computation as the withholding tax would no longer be available for credit relief against UK corporation tax. This could potentially be remedied by making a dividend exemption claim in conjunction with the withholding tax claim. Dividend exemption claims There is a significant body of ECJ case law (for example, Verkooijen) supporting the argument that the UK rules, which taxed overseas dividends received before 1 July 2009 but not domestic source dividends, are in breach of EU law. Investment funds in the UK should therefore consider making a claim to exempt overseas dividends received before 1 July 2009 from corporation tax in their UK tax returns. Claims to recover UK withholding tax on Manufacture Overseas Dividends (MODs) UK lenders are typically treated differently for UK tax purposes depending on whether it is a UK or overseas stock which has been lent out and on which a Manufactured dividend has been received. Manufactured dividend receipts relating to domestic stock are not subject to any UK withholding tax but MODs relating to overseas stock suffer UK withholding tax calculated by reference to the WHT rate in force in the relevant overseas country. There are strong arguments that this discriminating treatment is in breach EU law. Funds that participate in a stock lending program should consider making a MOD claim for the withholding tax on MODs to be refunded. Funds should also consider the impact of making a MOD claim will have on the UK tax computation and return. This could potentially be remedied by making a dividend exemption claim in conjunction with the MOD claim.

17 17 United Kingdom Taxation KPMG in the United Kingdom Rachel Hanger KPMG LLP 1 Canada Square Canary Wharf London E14 5AG United Kingdom Tel Fax Nathan Hall KPMG LLP 1 Canada Square Canary Wharf London E14 5AG United Kingdom Tel. +44 (0) Fax +44 (0) The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation.

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