Proposed BVI investment fund
Capital Gains Tax, Income Tax
Five unconnected individuals wanted to establish a private equity/venture capital fund (the ‘Fund’). The Fund vehicle was a limited partnership formed and tax resident in the British Virgin Islands (‘VC Fund LP’). The five individuals were to be the general partners in VC Fund LP. Three of those individuals were neither UK resident nor UK domiciled, one was UK resident and UK domiciled, and one was UK resident but South African domiciled. The three non-UK residents planned to operate from offices in the jurisdiction in which they were resident.
VC UK, a company incorporated and tax resident in the UK, would provide administrative and research services to the VC Offshore Investment Manager (‘VCOIM’). The directors and shareholders of VC UK were to be the two UK resident individuals. VCOIM would be a limited partnership formed and resident in the British Virgin Islands and would have the five individuals as the general partners. The Fund was to be closed-ended and invest in companies in the UK, Germany, Hungary, US, India, Singapore, Hong Kong and East and South Africa. The investments were be held through special purpose vehicles (‘SPVs’) which will also be located offshore as will the independent administrators and custodians to the Fund.
Potential investors were to be sophisticated high net worth individuals, family offices, and pension funds based in Singapore, Hong Kong, US, UK, India, East and South Africa. The investors would become limited partners in VC Fund LP.
Advice was sought on the UK tax consequences:
1. For VC UK of the provision of advisory services to VCOIM in exchange for a fee.
The fee charged by VC UK would be subject to the UK transfer-pricing rules as it would be paid to a business in a territory with which the UK does not have a double tax treaty with an appropriate non-discrimination article. This meant that the price had to be no less than it would be in an arm’s length transaction. The fee would be subject to UK tax in the normal way.
The supply of administrative and research services to VCOIM would be outside the scope of UK VAT provided that the supply was made to a ‘relevant business person’ who ‘belongs’ outside the EU. A ‘relevant business person’ includes any person who ‘independently carries out in any place any economic activity, whatever the purpose or results of that activity.’ A person ‘belongs’ in a country where he has his only business establishment or, if he has more than one such establishment, in the country where the business establishment which is most directly concerned with the supply is located. Assuming that the partners in VCOIM had a business establishment in the British Virgin Islands the supply could be made free of UK VAT.
2. For VC Fund LP of the structure.
A BVI limited partnership is not subject to tax in the British Virgin Islands. It does not have a separate legal personality from its members and is a ‘look-through vehicle’ for UK tax purposes (see HMRC International Tax Manual at INTM180030). This means that the UK resident partners would be taxable in the UK on their share of the profits of VC Fund LP as set out in the limited partnership agreement, whether or not that share was actually distributed. The UK resident partners would be regarded as being entitled to a share in the underlying income (and gains) received by VC Fund LP and would be charged to UK tax on the basis that the profit arose directly to them from the relevant investment made by VC Fund LP which was its source.
If the investments were held through SPVs which were not themselves tax transparent this could have UK tax disadvantages, in part depending on the jurisdiction in which the SPVs are tax resident and whether there was an applicable double tax treaty with the UK. The interposition of the SPVs could prevent a UK resident partner taking advantage of a double tax treaty between the UK and the source country in which the investment was taxed. UK provisions which gave credit for the underlying tax (tax paid by the foreign company on the profits out of which a dividend is deemed to have been paid) were are less generous than the credit system which applied under most of the UK’s tax treaties for tax paid on dividends. Underlying relief would only be available to corporate investors holding a minimum of 10% of the voting power in the company paying the dividend in any event. The use of the SPVs could also have the effect of turning a capital gain on an underlying investment into income in the hands of the UK resident partners. Unilateral relief would be given in cases where there was no treaty relief and the tax paid ‘corresponds’ to UK tax.
In the case of a direct share investment by VC Fund LP in a company taxed in a country with which the UK has a comprehensive double tax treaty (such as the USA) gains made on a disposal of those shares would normally be taxable only in the UK in a case where the shareholder was UK resident. If an SPV were interposed the tax treatment would depend on where that SPV was tax resident. Unilateral relief would also be given in cases where there was no treaty relief and the tax paid corresponded to UK tax.
3. For the general partners in VCOIM of the receipt of a fee from VC Fund LP and the return it receives from VC Fund LP on an exit from an investee company.
As VCOIM is tax transparent the UK resident partners would be taxed as set out in (2) above.
4. Of the receipt by VC Fund LP of the proceeds of an exit from an investee company.
The consequences for VC Fund LP would be as set out in (2) above.
Non-domiciled UK resident partners
An individual who is tax resident in the UK but not UK domiciled for a tax year can make a claim to be chargeable on the remittance basis for that year. Where the remittance basis applies ‘relevant foreign income’ and ‘foreign chargeable gains’ of the individual are taxed in the UK only if they are remitted to the UK, either directly or indirectly.
‘Relevant foreign income’ means chargeable income which arises from a source outside the UK and includes a partner’s share of the profits of a trade arising outside the UK for a tax year if the control and management of the trade is outside the UK, and dividends from non- UK resident companies. ‘Foreign chargeable gains’ means chargeable gains accruing from the disposal of an asset which is situated outside the UK.
Claiming non-domiciled status would therefore be of benefit in relation to income and gains accruing to the eligible UK resident partner in the two BVI limited partnerships.
Location of SPVs
Treaty shopping involves the ‘improper use’ of a double taxation agreement whereby a person acts through an entity created in another state with the main or sole purpose of obtaining treaty benefits which would not be available directly to such a person. Some treaties contain anti-treaty shopping or anti-conduit provisions. This should be borne in mind when deciding where to locate the SPVs. The requirements seemed to be:
1. No withholding tax (either because there is none under local law or because it is relieved by reason of an applicable double taxation agreement) when distributions are made to the partners in VC Fund LP (see answer to question 2 above).
2. Little or no tax on profits or gains as the interposition of the SPV would mean that that tax would not be creditable.
3. The possibility of making capital distributions of capital gains on exiting an investment.
4. The holding in the SPV must be a non-UK situated asset.
In view of the number of variables (and the fact that 1-3 above are matters of local law) it was impossible to make a firm recommendation without taking local advice. That said, Cyprus might be a possibility as it was understood that gains on the sale of shares were tax exempt, there was no withholding tax on dividends paid to a non-resident and a unilateral tax credit was available for tax paid abroad. Where a double tax treaty applied, treaty relief would apply if that was more generous. Cyprus’ corporation tax rate was 12.5%. Cyprus had double tax treaties with 48 countries. A list of them can be found here.
Update (at July 2015)
On 8 July 2015 the Chancellor announced proposals to change the rules applying to the UK taxation of non-doms. The necessary legislation will be included in the 2016 Finance Bill. In summary the changes are:
- the introduction of a deemed UK domicile rule for non-doms who have been UK resident for more than 15 of the past 20 tax years
- the introduction of rules making it harder for those who have a UK domicile at birth to claim non-dom status on their return to the UK where they have left the UK and acquired a domicile of choice in another country but subsequently return
At the time of publication this case study was technically accurate however, as tax law and practice change rapidly, you should take specific advice before taking any action.