Taxation of Investment Products

2 December 2009 Taxation of Pension Taxation Schemes of Investment Products A Consultation Document Issued by: 2 nd Floor Government Office Buck s Road Douglas IM1 3TX

Index Page 1 Background... 1 2 Investment Products - An Overview... 2 2.1 General... 2 2.2 Charging provisions... 2 2.3 Anti-avoidance legislation... 2 3 Insurance Bonds... 2 3.1 Current treatment... 3 4 Insurance Bonds - Proposed New Regime... 3 4.1 Consideration of other jurisdictions... 3 4.2 Summary of proposed new regime... 4 4.3 Qualifying policy... 4 4.4 Non-qualifying policy... 5 4.5 Time limit exemption... 5 4.6 Income charge point... 6 4.7 Income option taken... 6 4.8 No income option taken... 7 4.9 Overall loss... 8 4.10 Commencing residence... 9 4.11 Administration... 9 4.12 Personal portfolio bonds (PPB)... 10 4.13 Beneficial treatment for insurance bonds purchased and administered in the Island... 11 4.14 Transition... 11 4.15 Further comments... 11 5 Roll-up Funds... 11 5.1 Current practice... 11 5.2 Proposed new regime... 12 5.3 Definition... 12 5.4 Qualifying funds... 12 5.5 Qualifying investment test... 13 5.6 Example of qualifying funds - a non-uk CIS with UK distributor status... 13

5.7 Income tax charge... 13 5.8 Treatment of funds within the new UK Reporting Fund Regime... 14 5.9 Treatment of UK Authorised Investment Funds (including, most commonly, UK Open Ended Investment Companies (OEICs) and Authorised Unit Trusts (AUTs))... 14 5.10 Administration... 14 5.11 Funds falling outside the definition of fund in the proposed new regime... 14 6 Avoidance... 15 7 Submissions... 15 Appendix... 16

Taxation of Investment Products Consultation Document 1 Background The range of investment products is diverse, and determining how they should be treated within a taxation system is complicated. Investment products are designed to provide a return for the investor, and the key to any taxation policy is the determination of whether that return is of an income, capital or mixed nature. In a bank deposit account there can only be an interest income return, and the capital investment does not change in value. The acquisition of a Krugerrand can only result in a capital return based on an increase in the market value of gold (or a loss if the value goes down). Investing in company shares or unit trusts can result in income in the form of dividends and a capital return based on the value of the shares. In many jurisdictions, having both income and capital gains taxes makes matters more straightforward because income arising and capital appreciation can both be subject to taxation. The absence of capital taxes in the Isle of Man makes policy development more difficult. If we are to introduce a new policy, it will be necessary to consider the range of investment products in order to give certainty to investors and to allow the Assessor to offer equal treatment to all taxpayers; including, for example, those products designed to wrap an income-producing asset (in effect making it appear to be something else: for instance, an insurance contract) or to roll up income so that taxable receipts are deferred in some way or to convert income into capital. Earlier this year, through the Tax Liaison Committee (comprising representatives from the and private sector professions), a working party was formed to review the taxation of investment products. The remit of the working party was: to produce a document detailing the taxation position of the various products to propose to the Assessor and Treasury possible options for improvement. A Practice Note will be issued shortly clarifying the current taxation treatment of a number of investment products which are not dealt with in this document. In the meantime, this consultation document outlines proposals for the introduction of a new taxation regime for certain investment products. It is hoped that this document will generate debate and provide the Treasury with the information required to introduce new legislation where appropriate. Issue Date: 2 December 2009 Page 1

2 Investment Products - An Overview 2.1 General Four key principles determine the tax treatment of an investment product in the Isle of Man. They are: the charging provisions of the Income Tax Acts; the absence in the Isle of Man of capital gains tax; the Assessor s duty of care to safeguard income tax revenue; and anti-avoidance legislation. 2.2 Charging provisions Unlike the United Kingdom, the Island does not, in the main, have specific charging provisions for different types of investment product. Therefore, the starting point for any consideration of what is taxable has to be the general charging provision in Section 1 of the Income Tax Act 1970 ( the Act ), which imposes an annual income tax on: all incomes derived from property, professions, trade, salaries, wages, pensions, annuities, fees, emoluments, commissions, employments or vocations or from any source whatsoever. Section 2 of the Act further categorises income sources, in part by their nature but mainly as to whether the person who is to be taxed is or is not resident in the Isle of Man. Section 2 also emphasises that tax is to be charged on income, but always subject to exceptions or exemptions later in the Act. The only investment product-specific charging provision is for relevant discounted securities in Sections 2Q to 2Z of the Act. 2.3 Anti-avoidance legislation The anti-avoidance legislation is contained in Schedule 1 of the Income Tax Act 1980. Paragraph 1 (1) of Schedule 1 states, If the Assessor is of the opinion that the purpose or one of the purposes, of any transaction is the avoidance or reduction of the liability of any person to income tax, the Assessor may, subject to the provisions of this Schedule, make such assessment or additional assessment on that person as the Assessor considers appropriate to counteract the avoidance or reduction of liability. Whilst the Assessor seeks to apply the normal charging provisions in preference to the antiavoidance schedule, that schedule will be applied where a transaction achieves a reduction or postponement in tax liability which is considered to be unacceptable. 3 Insurance Bonds Insurance bond has become a collective term for a lump sum investment under the wrapper of an insurance product. These products are structured in such a way as to give an element of life assurance but in practice they bear all the hallmarks of an investment product. Issue Date: 2 December 2009 Page 2

3.1 Current treatment Where, in the Assessor s opinion, the purpose of the investment in an insurance bond is to produce an income, he will consider using the anti-avoidance provisions. However, each case is considered on its own merits. The Assessor s view is that where the insurance bond contains an income option and the bond holder elects for that option, the full amount of any withdrawal is charged to income tax. Where there is no option for an income withdrawal or where the option has not been taken, regular or more frequent withdrawals from the policy are treated as income. This interpretation has developed over a number of years and the term regular or more frequent is taken to mean withdrawals made more frequently than every three years. Where the taxpayer can clearly demonstrate that the withdrawal includes an element of the original capital or a specific element of capital gain, then that amount will be excluded from the charge to income tax. There are no specific charging provisions relating to insurance bonds within the legislation. When considering whether a gain on a product is taxable, the following factors are considered: Does the increase in the value of the investment fall within the normal charging provisions of the Income Tax Acts? Do the anti-avoidance provisions apply to a particular transaction? The anti-avoidance provisions will only be applied where a transaction achieves a deferment of liability which is considered to be unacceptable. Whilst the current system has been in operation for some time, there has always been a lack of certainty as to the taxation treatment of a bond. 4 Insurance Bonds - Proposed New Regime 4.1 Consideration of other jurisdictions United Kingdom The UK has introduced very complex legislation to tax insurance products which is known as the chargeable events regime. This regime applies when policy benefits are received from the insurer or the policy is assigned, including a partial assignment, to another holder for value: at which time a chargeable event arises. The amount of charge is not directly related to the value of the fund, but to the amounts withdrawn. Although, over the lifetime of the policy, there will be a correlation between the change in value of the fund and overall return, it is quite possible for significant mismatches to occur on partial withdrawals or assignments. Broadly, over its lifetime, the total charges on the policy will equate to the net gain upon it, namely, the difference between benefits received and premiums paid. Issue Date: 2 December 2009 Page 3

Guernsey Guernsey does not have any specific legislation relating to the taxation of insurance bonds. However, the tax treatment of these bonds is dealt with in Statement of Practice M18 and M18A (copy attached in Appendix). Jersey Jersey does not have any specific legislation or guidance relating to the taxation of insurance bonds. 4.2 Summary of proposed new regime The UK regime was considered too complex to be administered in the Island. However, the working party favoured the introduction of new legislation and the proposed new regime will be unique to the Island. It was considered essential that, in the new regime, the charge to income tax should be easy to understand and calculate. It is also important that the amount of income tax collected from the taxation of insurance bonds should not be less than the amount currently collected. The proposal is to differentiate between qualifying and non-qualifying insurance policies. Qualifying policies will not be taxable and will be defined: an example would be endowment policies. Non-qualifying policies will include, for example, single premium insurance bonds, and may be taxable. The treatment of non-qualifying policies can be summarised as follows: these policies will be subject to income tax only if an income charge point is triggered an income charge point will mainly occur when a withdrawal/encashment is made from the bond during its first 10 years an amount of deemed income will be assessable to income tax the deemed income will be based on a percentage of the bond value at the start of the year. 4.3 Qualifying policy In practice, there are a number of life insurance products that have never been subject to income tax, including, for example, endowment policies. In 1968, the UK recognised that large amounts of investments were flowing into short-term, investment-orientated policies, often single premium based. This called into question both the practice of granting relief and the practice of relying on the insurer s policyholder slice of tax to satisfy the policyholder s liability. Their solution was to restrict premium relief to qualifying policies and to introduce what is sometimes called an exit charge at the higher rate of tax. This is charged when events take place that result in the realisation of value from the policy. It is not appropriate to introduce a regime as complex as that of the UK in the Island. However, it is appropriate to introduce a definition of a qualifying policy which, similar to the Issue Date: 2 December 2009 Page 4

UK regime, will continue to fall outside the charge to income tax altogether. The UK definition of qualifying policy is contained in Section 267 and Schedule 15 of ICTA 1988. The main conditions to be satisfied by a qualifying policy are: minimum 10 year term broadly even spread of premiums, payable at least once a year a minimum sum assured equal to 75% of the premiums payable for the duration of the contract (originally for endowment policies and, from 1976, for term and whole life policies). It is proposed that a qualifying policy will not be charged to income tax in the Isle of Man and that a definition similar to that in the UK should be introduced. Do you agree that certain insurance products should not be charged to income tax? Are these conditions appropriate? Should any additional conditions be considered? 4.4 Non-qualifying policy Any policy that does not satisfy the required conditions will be non-qualifying. It will usually take the form of a single premium investment bond. These products will attract an income tax charge in certain circumstances and the charge will be calculated in the same way in all cases. In the current regime, it is not always clear whether there should be a charge to income tax or not. It is important that in the new regime any charge to income tax is easy to calculate and simple to operate. Looking through a bond to identify its underlying investments can be extremely complex in practice. As a result, it is rarely possible to calculate the bond s actual income which may be taxable. It is proposed, therefore, that a deemed amount of income will be calculated according to the value of the bond on the first day of the policy year and the income yield factor which will be set each year by the Treasury. The deemed income will be taxable as though it was income and any personal allowances or deductions would be allowable against it. The income yield factor will be based on an agreed formula and will recognise a general split between income and capital within the bond market. For example, the income yield factor could be based on Bank of England base rate plus 1%, or an average of the base rate for the year of assessment. We would welcome proposals for the formula to be used for the income yield factor. 4.5 Time limit exemption It will be generally accepted that where an investment has been made in an insurance bond and there is no income charge point during the first 10 years of the policy, then any profit from the bond will be deemed to be capital and not charged to income tax. Issue Date: 2 December 2009 Page 5

Movements between funds within a bond will not be treated as partial surrenders and will not, therefore, in themselves give rise to a tax charge. The surrender or partial surrender of a bond in order to invest in another bond or another type of investment will be treated as a surrender or partial surrender. Where the bond is either single premium or regular premium the time limit exemption will be taken from the payment of the last premium. Is a time limit exemption considered to be appropriate? Is 10 years appropriate? Should a cluster of policies be treated as though it is a single policy? 4.6 Income charge point It is proposed that a non-qualifying policy will be charged to tax on the deemed amount of income only in certain prescribed circumstances: 1. Where there is an encashment of any type, other than on death, from the bond at any time prior to the time limit for the charge (10 years) or, after that period where a previous withdrawal or charge point has occurred. 2. On the maturity of the policy, other than on death, if the maturity is prior to the time limit for the charge or, after that period but a previous withdrawal or charge point has occurred. 3. Where the whole policy is surrendered prior to the time limit for the charge or, after that period where a previous withdrawal or charge point has occurred. 4. Other points are to be considered: for example, where an individual leaves the Isle of Man prior to the time limit or, after the time limit but a previous withdrawal or charge point has occurred. Do you agree with the proposed income charge points? Should any other charge points be considered? 4.7 Income option taken For insurance bonds where the income option is taken, the deemed income to be charged to tax will be reasonably straightforward to calculate due to the spread of withdrawals over the life of the bond. Example 1 An individual invests 20,000 in a single premium non-qualifying policy. The income option is taken so the individual receives 200 a month for 10 years. Each year the individual will, therefore, withdraw 2,400 from the policy. The income yield factor for this example is 2%. For year 1 the value of the bond at the beginning of the year will be the initial premium paid of 20,000. Issue Date: 2 December 2009 Page 6

The deemed income in year 1 is: Value of the bond at the beginning of the first policy year x income yield factor = 20,000 x 2% = 400. In year 2 the value of the bond will be reduced by the withdrawals and will also fluctuate depending on the market conditions. If, at the beginning of the second year, the value of the bond is 18,000, the second year s deemed income to be charged to tax will be: 18,000 x 2% = 360. If, at the beginning of year 3, the value of the bond is 17,000, the third year s deemed income to be charged to tax is 340. It is important to note that the amount withdrawn from the bond will not be charged to income tax. This is completely different from the current UK tax system and the current Isle of Man regime. The amounts of deemed income will be included in the annual income tax assessment for each year. 4.8 No income option taken Where an income option has not been selected on the policy but withdrawals are made from the bond at irregular intervals, the income calculation will be slightly different. The amount invested in the bond will continue to have an amount of rolled up income and capital from year to year and, therefore, where there are fewer withdrawals over the life of the bond, it is important to add together the various deemed incomes for the appropriate years. Example 2 This example demonstrates that the proposed new regime is not concerned with the level of encashment from the policy and that the deemed income charge will reflect any large encashment that has occurred in the early years of the bond because the value of the bond will be reduced. An individual invests 20,000 in a single premium non-qualifying policy. The income option is not taken on the policy but the individual withdraws 15,000 during the first year and then the policy matures after 10 years with a value of 7,000. The income yield factor for each of the years is set for this example at 2%. For year 1 the value of the bond at the beginning of the year will be the initial premium paid of 20,000. The deemed income in year 1 is: Value of the bond at the beginning of the first policy year x income yield factor = 20,000 x 2% = 400. The deemed income when the policy matures is: Value of the bond at maturity x income yield factor x 9 years = 7,000 x 2% x 9 = 1,260. Issue Date: 2 December 2009 Page 7

Therefore, the total income charged is 1,660. Example 3 An individual invests 20,000 in a single premium non-qualifying policy. The income option is not taken on the policy but the individual withdraws 5,000 during year 5 when the policy value is 25,000. The policy then matures after 10 years with a value of 23,000. The income yield factor for each of the years is set for this example at 2%. The deemed income at the beginning of year 5 is: Value of the bond at the beginning of policy year 5 x income yield factor x 5 years = 25,000 x 2% x 5 = 2,500. The deemed income when the policy matures is: Value of the bond at maturity x income yield factor x 5 years = 23,000 x 2% x 5 = 2,300. Therefore, the total income charged is 4,800. 4.9 Overall loss Where an individual can prove that the return on an insurance bond is actually less than the amount invested, the Assessor may allow relief for the deemed income already charged. Only where a bond has been held to maturity or is surrendered and the total return from the bond, including previous encashments, is less than the original amount invested, will this relief be available. It is proposed that the amount of any excess deemed income charged over the life of the bond will be allowed to be offset against other income in the final year of the bond. Comments are requested on whether any form of relief is appropriate. Example 4 An individual invests 20,000 in a single premium non-qualifying policy. The income option is not taken but the individual withdraws 5,000 during year 5 when the policy value is 25,000. The policy then matures after 10 years at a value of 10,000. The income yield factor for each of the years is set for this example at 2%. The deemed income at the beginning of year 5 is: Value of the bond at the beginning of the policy year 5 x income yield factor x 5 years = 25,000 x 2% x 5 = 2,500. Issue Date: 2 December 2009 Page 8

The deemed income when the policy matures is: Value of the bond at maturity x income yield factor x 5 years = 10,000 x 2% x 5 = 1,000. The total deemed income charged on the bond is therefore 3,500. However, the first encashment of 5,000 together with the maturity value of 10,000 is less than the total invested of 20,000. The deemed income charge in the year of maturity will therefore not be due and the deemed income charge of 2,500 already charged in year 5 may be available for offset against other income in the year the bond matures. 4.10 Commencing residence Where an individual who already holds an insurance bond commences residence in the Island, it is proposed that the deemed income will be calculated from the time the individual became resident and not for the time the bond has been held. Comments are requested. Example 5 An individual invested 20,000 in a 15 year insurance bond in the year 2000 and commenced residence in the Island in 2005. The individual makes a withdrawal during 2008 of 5,000 when the policy value is 25,000. The income yield factor for each year is set for this example at 2%. Although the bond has been held for 8 years at the point of the withdrawal, only the time the individual is resident in the Island will be used for the calculation of deemed income. The deemed income chargeable in 2008 is: Value of the bond at the beginning of the year of encashment x income yield factor x 3 years = 25,000 x 2% x 3 years = 1,500. 4.11 Administration It is proposed that new reporting requirements will be introduced which will require Isle of Man residents to declare annually on their tax return details of any non-qualifying insurance products that they hold and any withdrawals or encashments that have been made. Comments are requested. Issue Date: 2 December 2009 Page 9

4.12 Personal portfolio bonds (PPB) In law, it is the insurer, not the policyholder, who owns the property that determines the benefits under a life policy. Where the policyholder has the ability to select the property that determines the policy benefits, the policyholder retains nearly all the advantages of direct personal ownership of that property. However, because the property is held in the wrapper of a life insurance policy, the policyholder does not pay income tax on dividend and interest income arising from the investments. Tax on any income on the policy can also be deferred until the policy comes to an end. The Assessor is aware of the potential to use such bonds for the avoidance or deferral of income tax or to convert income into a capital gain. Rather than use the anti-avoidance provisions on a case by case basis, it is proposed that these bonds will all be subject to an annual deemed income charge. This charge will be due annually whether or not there has been a withdrawal or encashment. The charge will be calculated according to the amount invested in the bond and will not necessarily be calculated using the original premium, which may be minimal. It is proposed that the definition of a PPB in the Island should be similar to the definition used by the UK. However, the UK permits bonds to make certain investments without being a PPB and any gain arising on the bonds will eventually be charged to income tax. The Island has no capital gains tax and, therefore, cannot permit certain types of investment to be held tax free within a PPB. It is, therefore, proposed that a personal portfolio bond is a life insurance, life annuity or capital redemption policy under whose terms: (a) (b) some or all of the benefits are determined by reference to the value of, or the income from, property or to fluctuations in the value of such property or to fluctuations in an index of the value of property; and some or all of the property concerned may be selected by the policyholder (or by a person connected with them). The policyholder can nominate a portfolio of investments to be held by the insurer in a fund linked to the policy and, on maturity of the policy, he is entitled to an amount determined by reference to the income and capital gains which have accrued on that portfolio. Policies which allow the policyholder to select from a list of funds provided by the insurer would not be PPBs. The critical issue is whether the policyholder has the ability to select the property held in the policy, or whether property may be selected by: a person acting on the policyholder's behalf; a person connected with the policyholder; a person acting on behalf of a connected person; or any combination of the above (in either the singular or plural). If the insurer has complete discretion to determine the policy benefits, the policy is not a PPB and will, therefore, be treated in the same way as any other insurance bond. If the terms of the policy allow the holder to select or influence the selection of the property that Issue Date: 2 December 2009 Page 10

determines the policy benefits, then the holder has the ability to select. However, the policyholder's ability to select the level of risk of the fund does not amount to an ability to select the policy benefits. Comments are requested on the definition of personal portfolio bond to be used in the Island. Should personal portfolio bonds be treated differently? 4.13 Beneficial treatment for insurance bonds purchased and administered in the Island It would be possible to introduce a more favourable income tax treatment for insurance bonds that are purchased and administered in the Island. There are a number of ways that this could be achieved including lengthening the exemption time limit or increasing the income yield factor for off-island policies. This would help to encourage the local insurance industry. Do you consider that there should be a more favourable income tax treatment for insurance bonds that are purchased and administered in the Island? Please comment on how this could best be achieved. 4.14 Transition It is proposed that the previous tax treatment of bonds should be ignored in the new regime and that all bonds will be covered when the new legislation is introduced. Transition rules would also allow for any withdrawals prior to the introduction of the legislation to be ignored. Do you have any suggestions regarding the introduction of the new regime? 4.15 Further comments Do you have any further suggestions or comments regarding the proposals? 5 Roll-up Funds 5.1 Current practice The tax treatment of roll-up funds has developed over a number of years. The Assessor only taxes the income from a roll-up fund when it is cashed in. This does not apply where the investor ceases residence in the Isle of Man or dies. In such cases, all rolled-up income is taxed with reference to the relevant event. The Assessor does not seek to tax any element of capital gain crystallising on an encashment. Where the separate amounts of capital and income gain can be clearly Issue Date: 2 December 2009 Page 11

demonstrated, the split will normally be accepted for tax purposes. Where the split cannot easily be demonstrated, the Assessor is prepared to accept a split of 85% income and 15% capital. Where there is a currency or trading gain in a roll-up fund, then 100% of the gain will be treated as income. Where a taxpayer has a substantial portfolio of income-producing investments including a roll-up fund, the Assessor will, by concession, not tax the roll-up fund gain provided that it does not exceed ten percent of a balanced portfolio. Currency conversion gains on encashment will be accepted as being of a capital nature and not subject to income tax. Equally, currency conversion losses will not be deductible for tax purposes. With some roll-up funds it is possible to change the component investments. For tax purposes, where the change is between investments with different income/capital splits, it will be treated as an encashment. 5.2 Proposed new regime The current treatment of roll-up funds is very complex and does not give any certainty to the investor. The Assessor has never published a definition of a roll-up fund and, therefore, there is a great deal of uncertainty as to exactly what a roll-up fund is and whether or not it is subject to income tax. It is proposed that a similar approach be taken with roll-up funds to that being taken with insurance bonds. Roll-up funds will be properly defined, will be treated as either qualifying or non-qualifying funds and will be chargeable or otherwise to income tax in a similar way to insurance bonds. The new regime will seek to tax funds that either roll-up income or that invest predominantly in cash or debt-like instruments. 5.3 Definition It is proposed that a fund will be defined using the Collective Investment Scheme (CIS) definition within the Collective Investment Schemes Act 2008; a chargeable fund within the new regime will be a fund which is not a qualifying fund. Do you agree with this definition of a roll-up fund? Please suggest any alternatives. 5.4 Qualifying funds It is proposed that a qualifying fund will be any fund that falls into one or more of the following categories: Any fund that distributes more than 85% of its income annually. Any fund where the net income is subject to a foreign rate of tax of not less than 18% at the fund level. Any fund that meets the qualifying investment test. Issue Date: 2 December 2009 Page 12

An investment in a qualifying fund will not fall within the scope of this new regime and qualifying funds will, therefore, not be chargeable to income tax. Any fund that is not a qualifying fund will be a non-qualifying fund. Do you agree with this definition of a qualifying fund? Please suggest any alternatives. 5.5 Qualifying investment test It is proposed that an investment test should be introduced for funds and that this should be similar to the test within the European Union Savings Directive. Therefore, where a fund invests directly or indirectly less than a certain percentage of their assets in debt claims, it will be a qualifying fund. In determining whether a fund s investment in debt claims exceeds a percentage of its total assets, attention should be focused on the fund s investment policy set down in its rules or constitution. When there is no information concerning the investments of a fund, the fund will be considered to be non-qualifying. Do you agree that there should be a qualifying investment test for funds? If you are in favour of the investment test, what percentage of assets should be allowed to be invested in debt claims? What percentage of total assets should be allowed in debt claims? 5.6 Example of qualifying funds - a non-uk CIS with UK distributor status The UK has a tax regime (known as the offshore funds regime) which deals with the taxation of UK residents investing in offshore funds (broadly, collective investment vehicles situated outside the UK). Under current UK legislation, such an offshore fund will be treated as either a distributing fund (in which case, gains on disposal are taxed as capital gains) or a non-distributing fund (in which case, gains on disposal are taxed as income). In order to obtain distributor status the fund must, inter alia, distribute at least 85% of its net income within six months of the end of each accounting period. Thus, any fund that is a distributor status fund from a UK tax perspective will, by virtue of distributing at least 85% of its net income, be treated as a qualifying fund for Isle of Man tax purposes. The income distributed should be declared annually and taxed as usual. 5.7 Income tax charge The amount of tax charged will be based on the same income yield factor as for insurance bonds but there will be no reduction for the income/capital split. The charge will be imposed on Isle of Man residents who hold an investment in a non-qualifying fund. As the charge is only aimed at funds that invest predominantly in cash or debt-like instruments, it will be made annually. Issue Date: 2 December 2009 Page 13

Example 6 An individual invests 50,000 in a Sterling roll up fund. Although the individual does not withdraw any of the funds, there will be an annual deemed income charge based on the amount invested. For instance, if the income yield factor was 2%, this would be 2% of 50,000 annually or 1,000. As the taxpayer is charged to income tax annually on the deemed income, when the fund is eventually encashed there will be no further income tax charge. 5.8 Treatment of funds within the new UK Reporting Fund Regime Under the replacement for the UK distributor status regime, offshore CIS will be either "Reporting Funds" or "Non-Reporting Funds". UK investors will be taxed on 100% of their share of the net income (but not gains) of a Reporting Fund, regardless of how much is distributed. It is proposed that a person resident in the Island will be taxed in the same manner as that in the UK when they invest in a fund that has UK Reporting Fund status. It is proposed that legislation should be introduced to ensure that the share of income reported by the fund on an annual basis will be taxable as income. 5.9 Treatment of UK Authorised Investment Funds (including, most commonly, UK Open Ended Investment Companies (OEICs) and Authorised Unit Trusts (AUTs)) These are investment funds authorised under UK Legislation. Both OEICs and AUTs are liable to UK corporation tax on income. Although there is no requirement on OEICs and AUTs to physically distribute net income, 100% of such income is treated as having been paid to investors for UK tax purposes. Such companies will issue income statements or equivalents to investors. It is proposed that legislation should be introduced to ensure that these are taxed in the same manner as in the UK and any double tax relief will be granted as appropriate. Do you agree with the proposed treatment set out in 6.8 and 6.9? 5.10 Administration It is proposed that new reporting requirements will be introduced which will require Isle of Man residents to declare annually on their return form details of any investments they have in collective investment schemes and the value of such investments at the beginning of the year. Comments requested. 5.11 Funds falling outside the definition of fund in the proposed new regime Within the proposed new regime for funds, the following do not fall within the definition of a fund: Issue Date: 2 December 2009 Page 14

1. UK Investment Trusts These are closed ended companies and, therefore, not CIS under the Isle of Man definition. However, they are liable to UK corporation tax on income (but not gains) and are required to distribute at least 85% of net income. 2. UK Real Estate Investment Trusts These are closed ended companies. They must distribute at least 90% of net rental income profits to investors (withholding UK tax at the basic rate). 3. Other closed ended companies generally These would not fall within the definition of CIS. 6 Avoidance Given that the new rules will make any income on insurance bonds and roll-up funds easier to calculate and there will be specific charging provisions written into the income tax legislation, it is not envisaged that the general anti-avoidance provisions will be frequently used. However, where, in the Assessor's view, an investment is designed to avoid Isle of Man tax, the anti-avoidance provisions will be used to tax the investment. 7 Submissions Anyone wishing to submit their views on the topics in this document, or on any other issue related to the policy on taxation of investment products, is invited to do so by Friday 29 January 2010, to: Claire Terry Policy Officer 2nd Floor Government Office Buck s Road Douglas IM1 3TX Email: consultation@itd.treasury.gov.im Issue Date: 2 December 2009 Page 15

Appendix Guernsey Statement of Practice M18 and M18A M18 LIFE ASSURANCE POLICIES (INCLUDING SINGLE PREMIUM LIFE ASSURANCE BONDS) A tax liability may arise where the Administrator wishes to invoke the legal avoidance provisions of the Income Tax Law and he reserves the right to do so in all cases. Generally this will not be done in the case of full or partial surrenders or maturity if the investment has remained untouched for at least ten years, i.e. has not given rise to income in any form. If the investment is surrendered in full or matures before ten years have elapsed, any growth on the investment would generally be taxed as income. However, a sympathetic view will be taken if the investor has been forced to surrender the policy because of some external circumstances beyond his control. Where a partial surrender is made (for example, to take a regular withdrawal) then that and any subsequent surrenders will be examined to ascertain the growth in the investment. Any such growth will be taxed. The method of calculation will vary according to the nature of the investment. For unitised policies the income will be calculated by reference to the original unit cost and the number of units surrendered. In other cases the following formula may be used to ascertain the original cost: A A + B Where A = the cash received B = the value of the remaining investment after the partial surrender. Clusters of policies would generally be treated as one investment so that the surrender of one policy would constitute a partial surrender of the whole. Movements between funds within a bond would not be treated as partial surrenders and would not therefore in themselves give rise to a tax charge. The surrender or partial surrender of a bond in order to invest in another bond or another type of investment would be treated as a surrender or partial surrender, as the case may be, for the purposes of this Statement of Practice, but see M18A below. No liability would arise on any death benefit paid. A claim for relief in respect of Guernsey or foreign taxes already suffered on any income charged to tax under the above would only be given if the taxpayer can demonstrate that he suffered the tax personally rather than through a third party (for example tax suffered by the insurance company). The taxpayer would only be taxed on the net income received if a tax credit was not available. Issue Date: 2 December 2009 Page 16

As explained above, the Administrator reserves the right to invoke the legal avoidance provisions of the Law where appropriate. It has come to his attention that in some cases bonds are being purchased for the principal purpose of holding an underlying portfolio of investments (whether already owned or subsequently purchased) in order to obtain the protection of the 10 year concession afforded by this Statement of Practice. He wishes to make it clear that, in such cases, there is a very strong likelihood that he will, in fact, invoke the anti-avoidance provisions in order to protect States revenues as this is not the intended purpose of the 10 year concession. This statement does not apply to Corporate Life Assurance Contracts, i.e. any life assurance policy held in the name of a company rather than an individual, where the treatment will vary according to the purpose for which the contract is taken out. This statement does not apply to purchases of second-hand endowment policies and the whole of the profit on surrender or maturity will be charged to income tax. M18A FURTHER CONCESSIONARY TREATMENT FOR 2009 REGARDING THE SWITCHING OF FUNDS IN SINGLE PREMIUM LIFE ASSURANCE BONDS In view of the current financial climate, and particularly in view of concerns regarding investor protection, it has been agreed that, in certain circumstances, funds may be switched from one bond to another without the transfer breaking the 10 year rule, provided that: the switch has been made as a result of advice given by a professional adviser, it has been made for the sole purpose of giving greater protection to the underlying funds, the whole of the funds in the original policy are transferred to the new policy, and the switch is made by 31 December 2009. Where all of the above criteria are satisfied, the commencement date of the original policy would remain as the relevant date when considering whether the funds have remained untouched for 10 years on any subsequent withdrawal/redemption. Issue Date: 2 December 2009 Page 17