Everybody is outraged about offshore investment funds – because nobody understands what they are or what they do
9 November 2017
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Brexit
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1 November 2024
I really must re-tune the alarm clock so that I am not woken in the morning by the BBC trying to drum up a bit of outrage about offshore investments.
Another load of personal data has been stolen from a law firm, and the BBC is trawling through it with prurient glee, trying to find some famous names that it can expose.
What’s in a name?
Their main piece this morning is that the Duchy of Lancaster, the historic estate that provides financial support to the monarchy, has put some money into offshore investment funds.
As the BBC has to admit, this is entirely legal. But what they don’t explain is how there can be anything wrong about it.
We are clearly supposed to think that just because a Caribbean finance centre is involved, something bad is going on. But that trick only works if we don’t understand what is actually happening.
What do offshore investment funds do?
Offshore investment funds do not avoid tax, because the alternative to an offshore fund would not result in any more tax. All the offshore fund does is allows investment management to be simplified and improved.
An investment fund is just a convenient way to manage money. Various investors put their capital into it, which is then professionally managed and invested into various businesses.
The offshore investment fund does not change the tax position. The businesses the fund invests in are taxable wherever they are based. The investors are taxable on the income and gains they receive from the fund wherever they are based in. Indeed one feature of offshore funds is that they often have investors and investments from a variety of different countries, something that is complicated for an onshore fund.
While it is legitimate for the businesses and the investors to be taxed, we don’t want the investment fund to be taxable itself; that would be triple taxation. The fund is not meant to be a taxable person; it doesn’t benefit itself from the investment income or gains; it is just a mechanism for the investors to invest more efficiently.
But if the investment fund were a UK company, rather than being based in the Caribbean, it would be taxable. Investing through a fund would therefore add a 19% tax charge onto much of the investment income, even though the fund isn’t a real person, it is just a way for the investors to have their capital managed.
No more tax
So the alternative to an offshore fund would not be a UK corporate fund, which would add an additional layer of tax. If these large investors did not use the offshore investment fund, they would not use a fund at all. Instead they would make their own investments directly and, instead of a fund manager investing it for them, they would have professional advisers telling them where to invest their money.
That would not leave them paying any more UK tax than they do using the offshore fund. With the investors investing directly, the companies they invest in would still pay tax on their profits and the investors would pay tax on their investment returns, exactly the same as with the offshore investment fund, but because there would be no investment fund, there would be no-one else involved to be taxed.
These large investors such as the Duchy of Lancaster and the very wealthy individuals named in these leaked papers generally have enough investments that they could hire their own professional advisers in this way. If they were prevented from investing in offshore funds (or embarrassed out of it), the result would not be a penny more tax. It would not be worth the extra layer of tax that would result from investing in a UK fund; instead they would invest directly, not using a fund at all.
Everyone would be poorer
But that would be less efficient; it makes much more sense to have collective investment funds where one expert professional team can pool funds from various investors and manage them together.
So the effect of these hyped-up stories will not be that more tax will be paid; it will be less professional management of investments, with more people making their own investments rather than using funds. That means less efficient use of capital and it will be more difficult for businesses to access the investment they need, so ultimately we all become worse off.
And it will not just be less efficient investment for the wealthy or large institutions; it will also make it more expensive for the rest of us to invest.
Many of these offshore funds are also available to smaller retail investors; individuals or small pension funds. Even a lot of investment funds offered by “High Street” financial institutions actually have their funds domiciled in an “offshore tax haven” – either the Caribbean or somewhere like Luxembourg. At the moment the wealthy and big institutions also invest in these funds, which helps spread the cost and bring the fees down for all of us.
If the offshore funds are closed down, the wealthy investors will stop using collective investment funds; they can afford to hire their own investment advisers and invest directly. But the rest of us can’t, and without being able to join in with the big investors we will be left with less choice of investment funds and higher fees.
Developing countries and technologies
These offshore funds are particularly important for specialist investments, where most investors are not large enough to have their own adviser on every niche area. Funds investing in developing countries, for example, or in green technology, need expert professionals to handle and arrange the investments, but most investors would only want to risk a small part of their capital in such specific areas and would not have the knowledge to do it themselves, or be able to justify hiring expert advisers in such a limited field.
Only an offshore investment fund can draw in capital from many investors all over the world, creating a large enough pot to employ specialists to manage it, and therefore get vital investment to difficult places where it is really needed.
If we discourage investors from investing in these specialist offshore funds, the result will be less investment into these areas, particularly the developing world, because it will simply be too difficult for the investors to do alone. Which would we prefer – that they invest in developing countries and new technology through an offshore fund, or that they pour even more cash into the already over-heated London property market?
All worse off
So what can be the objection to offshore investment funds?
Not only are they perfectly legal, but also the alternative would be less specialised investment management, less capital available for new technologies and developing countries, and less investment choice and higher fees for ordinary investors who can currently piggy-back on the big investors.
One thing we wouldn’t get, if the wealthy and big institutions stopped investing via offshore funds, would be any more tax. Instead, by making investments less efficient, these campaigns will make us all poorer.
Another load of personal data has been stolen from a law firm, and the BBC is trawling through it with prurient glee, trying to find some famous names that it can expose.
What’s in a name?
Their main piece this morning is that the Duchy of Lancaster, the historic estate that provides financial support to the monarchy, has put some money into offshore investment funds.
As the BBC has to admit, this is entirely legal. But what they don’t explain is how there can be anything wrong about it.
We are clearly supposed to think that just because a Caribbean finance centre is involved, something bad is going on. But that trick only works if we don’t understand what is actually happening.
What do offshore investment funds do?
Offshore investment funds do not avoid tax, because the alternative to an offshore fund would not result in any more tax. All the offshore fund does is allows investment management to be simplified and improved.
An investment fund is just a convenient way to manage money. Various investors put their capital into it, which is then professionally managed and invested into various businesses.
The offshore investment fund does not change the tax position. The businesses the fund invests in are taxable wherever they are based. The investors are taxable on the income and gains they receive from the fund wherever they are based in. Indeed one feature of offshore funds is that they often have investors and investments from a variety of different countries, something that is complicated for an onshore fund.
While it is legitimate for the businesses and the investors to be taxed, we don’t want the investment fund to be taxable itself; that would be triple taxation. The fund is not meant to be a taxable person; it doesn’t benefit itself from the investment income or gains; it is just a mechanism for the investors to invest more efficiently.
But if the investment fund were a UK company, rather than being based in the Caribbean, it would be taxable. Investing through a fund would therefore add a 19% tax charge onto much of the investment income, even though the fund isn’t a real person, it is just a way for the investors to have their capital managed.
No more tax
So the alternative to an offshore fund would not be a UK corporate fund, which would add an additional layer of tax. If these large investors did not use the offshore investment fund, they would not use a fund at all. Instead they would make their own investments directly and, instead of a fund manager investing it for them, they would have professional advisers telling them where to invest their money.
That would not leave them paying any more UK tax than they do using the offshore fund. With the investors investing directly, the companies they invest in would still pay tax on their profits and the investors would pay tax on their investment returns, exactly the same as with the offshore investment fund, but because there would be no investment fund, there would be no-one else involved to be taxed.
These large investors such as the Duchy of Lancaster and the very wealthy individuals named in these leaked papers generally have enough investments that they could hire their own professional advisers in this way. If they were prevented from investing in offshore funds (or embarrassed out of it), the result would not be a penny more tax. It would not be worth the extra layer of tax that would result from investing in a UK fund; instead they would invest directly, not using a fund at all.
Everyone would be poorer
But that would be less efficient; it makes much more sense to have collective investment funds where one expert professional team can pool funds from various investors and manage them together.
So the effect of these hyped-up stories will not be that more tax will be paid; it will be less professional management of investments, with more people making their own investments rather than using funds. That means less efficient use of capital and it will be more difficult for businesses to access the investment they need, so ultimately we all become worse off.
And it will not just be less efficient investment for the wealthy or large institutions; it will also make it more expensive for the rest of us to invest.
Many of these offshore funds are also available to smaller retail investors; individuals or small pension funds. Even a lot of investment funds offered by “High Street” financial institutions actually have their funds domiciled in an “offshore tax haven” – either the Caribbean or somewhere like Luxembourg. At the moment the wealthy and big institutions also invest in these funds, which helps spread the cost and bring the fees down for all of us.
If the offshore funds are closed down, the wealthy investors will stop using collective investment funds; they can afford to hire their own investment advisers and invest directly. But the rest of us can’t, and without being able to join in with the big investors we will be left with less choice of investment funds and higher fees.
Developing countries and technologies
These offshore funds are particularly important for specialist investments, where most investors are not large enough to have their own adviser on every niche area. Funds investing in developing countries, for example, or in green technology, need expert professionals to handle and arrange the investments, but most investors would only want to risk a small part of their capital in such specific areas and would not have the knowledge to do it themselves, or be able to justify hiring expert advisers in such a limited field.
Only an offshore investment fund can draw in capital from many investors all over the world, creating a large enough pot to employ specialists to manage it, and therefore get vital investment to difficult places where it is really needed.
If we discourage investors from investing in these specialist offshore funds, the result will be less investment into these areas, particularly the developing world, because it will simply be too difficult for the investors to do alone. Which would we prefer – that they invest in developing countries and new technology through an offshore fund, or that they pour even more cash into the already over-heated London property market?
All worse off
So what can be the objection to offshore investment funds?
Not only are they perfectly legal, but also the alternative would be less specialised investment management, less capital available for new technologies and developing countries, and less investment choice and higher fees for ordinary investors who can currently piggy-back on the big investors.
One thing we wouldn’t get, if the wealthy and big institutions stopped investing via offshore funds, would be any more tax. Instead, by making investments less efficient, these campaigns will make us all poorer.
16 thoughts on “Everybody is outraged about offshore investment funds – because nobody understands what they are or what they do”
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Oh come on, it’s just a big tax dodging scam.
Well explained.
Thank you for adding some light to the debate. Too much heat so far.
Finally, someone talking sense!
Hi Jeremy
I totally agree with the piece you have put together to make people understand what investment funds is and what they do. But I believe the issue with media report is not so much of tax avoidance by the monarch (Prince Charles) or there is wrongdoing for investing in offshore funds. I think it more to do with Conflicts of Interest by the Prince lobbying the government to lift ban on climate issue that will open up investment opportunities for the vehicle he has invested in.
Regards
Ajibade
Fails on the 3rd paragraph of ‘what they do’. So they are subject to 0% tax offshore , instead of say 20% in the UK.
Situation would be resolved by the investing personand/or company being taxed in the domicile they are based. e.g Amazon, Google, etc
So You seemed to have just confirmed,, what i thought,, Companies,, People,, Pay no tax on the funds,, as they are only taxed on what the un-taxed investments “Make”,, and your saying if they did not invest into these off shore Tax Free investment funds,, they would find another way to invest there money Tax Free.. and without these companies/people investing these funds into off shore investments,, those places that reap all the investment profits from these off shore investors,,would suffer,, Bottom Line is the first Line I wrote,, there doing this to avoid paying a higher TAX from there home countries,, I personalty think this is wrong,, but if I had a lot of profits from a company i would be doing the same thing,, it’s all about making more money from your profits/investments,, should the home Countries have the right to TAX these off shore investments,,, My Answer is YES..!!!!!
They only exist for one purpose – tax avoidance. You can dress it up all you like, but that’s the bottom line.
Interesting how the bbc relies on stolen information as their reliable source of misinformation A new low for journalism by the BBC. You would think any independent journalist would start by focusing on why the information they use was hacked in the first place. Relying on stolen information means they sanction such illegal behavoir. It deems them an accomplice. They are doing everything to cast doubt, increase divisivion among the public because they are drowning from brexit. It is another sad day for BBC. To rely on tactics that employ division should be a red flag.
Bermuda is not in the Caribbean
Very well explained and reasoned article, however it does not address the tax avoidance aspect of using these investment vehicles. It was shown that individuals were placing their assets in to a trust that should have been outside of their control, but were still using the trusts for personal gain.
When you can use a fund, which you supposedly have no direct control over, to buy fine wines, works of art and high end sports cars, then that appears to be a direct gain and therefore taxable. There were other examples given in the programme, but I suppose the question must be asked is how many others remain undetected and what that would represent in lost taxation to HMRC.
PLEASE KINDLY NOTE THAT AS BRITISH PAKISTANI.. IT HAS DISTURBED THE COMMUNITY THAT EX-PM MR SHAUKAT AZIZ HAS AN OFF -SHORE FUNDS IN THIS NEW PRESS RELEASE
COULD KINDLY FOCUS ON THIS ISSUE AND ADVISE
Clearly, some readers have not understood the article. It addresses the issue of investing in “offshore funds”. This means, in the case of UK investors, non-UK funds, such as Cayman, Ireland, Luxembourg, etc. The main point is that the fund itself is not taxed on the income and capital gains. The investor is liable for the tax in his home country (in this case, the UK) for all income and realized capital gains. The companies in which the fund invests are of course taxable like all companies in the UK. The issue of UK investors investing in an offshore fund and not declaring any income or capital gains to HMRC is now a moot point as the Common Reporting Standard is now widely implemented around the world. This standard developed by the OECD provides for the automatic sharing of tax information amongst countries. There are complex rules related to trusts, companies and other structures, but for the average UK-domiciled investor, these structures are generally ineffective in avoiding tax. Outright tax evasion is illegal with very severe penalties. Tax avoidance runs from what the HMRC calls “abuse” and there is a rule now applied preventing this to legitimate tax planning utilizing various reliefs offered under the legislation (personal exemption, ISA, pensions, etc). Going back to the point of the article, if countries force other territories to tax investment funds in their own right, then investors will simply invest directly in the companies, government debt, commodities etc. Not a single penny of extra tax will be collected. The investor would still pay on income received and capital gains realised and the target companies would still pay corporation tax. The effect would be to make investments much more cumbersome and inefficient, reducing the rate of return for all cross-border investors. Therefore it is better to have so-called “offshore funds” as they have a net beneficial effect on the economy and investors, including the man on the street with a pension.
Thanks for that comment Christopher. Brought me down below boiling point again.
Question: I realize this is geared toward a UK audience and is about UK laws. Are there no pass through entities in the UK? That seems kind of crazy to me, but I don’t know.
In the US, we have LLCs, LLPs, Partnerships, Sole Proprietorships, and S-Corps, where you can pass through income to the owners’ personal tax returns. I think only C-corps, which includes basically all publicly traded companies, and very few privately held companies, are taxed on corporate profits at the entity level.
Why then, would anyone in a jurisdiction with pass through entities, use one of these offshore accounts. Isn’t it the case, that many, probably the majority of these investors, have other pass through options in their home jurisdictions? Why go to the trouble of the offshore account?
In response to Alex: yes there are pass through entities in the UK, LPs and LLPs. Indeed the LP is the structure adopted by the majority of onshore private equity and hedge funds.
The author is either woefully misinformed or being disingenuous when he writes:
“if the investment fund were a UK company, rather than being based in the Caribbean, it would be taxable. Investing through a fund would therefore add a 19% tax charge onto much of the investment income, even though the fund isn’t a real person, it is just a way for the investors to have their capital managed.”
If a fund were to move onshore it would be constituted as an English (or Scottish) LP. Investors would be subject to tax in their own jurisdiction in exactly the same fashion as if they were off shore – it would not add a 19% tax charge. It’s frankly embarrassing that a Senior Lecturer in Taxation is this misinformed on UK fund vehicles.