The taxing question of ETFs

Providers came under pressure last year when HMRC revised the tax treatment of offshore funds. Joanne Young asks how ETF issuers have dealt with the changes and what issues remain

In December 2009, HMRC introduced the reporting fund regime for all offshore funds with UK investors. Replacing the UK distributor status (DS) regime, the conversion meant all ETFs domiciled outside of the UK would have to apply for reporting fund status (RFS) in order to be eligible for capital gains rather than income tax. 

In many respects it is easier for an ETF to gain RFS than DS, but the transition is significant in an industry in which the vast majority of UK-listed ETFs are domiciled offshore.

The following summer in 2010, a BlackRock study prompted a flurry of headlines after it revealed that roughly a quarter of the 239 ETFs then listed in the UK did not have distributor or reporting status – leaving returns subject to income tax. 

With income tax rates rising as high as 50% last year, against a ceiling of 28% on capital gains tax, the differential and impact on investors’ returns is potentially significant. In the months following the publication, ETF providers were inundated with calls from worried investors. 

BlackRock’s director of tax Roger Exwood said he was surprised by the media storm that followed the firm’s report on tax statuses. “We have always made that information very clear on our fund factsheets, but it was a reminder that there is a portion of the market that comes to us through online brokers perhaps without referring to our material.” 

Deloitte tax partner Ali Kazimi argued the episode was more significant for investor perception than the actual danger posed to returns. He added: “It was a genuine problem in terms of investors not knowing what was happening. But ETF providers have woken up very quickly to the fact that they simply will not have a distribution model in the UK if they fail to get RFS.”

After the storm
Providers are keen to emphasise that they have moved on. All but one of the ETFs on iShares’ UK platform has RFS: iShares S&P Listed Private Equity. Both Lyxor and db x-trackers said their UK-listed ETFs will be compliant with either distributing or reporting fund requirements as one regime transitions into the other.