Tax in fund of funds

A bit more on TR13/8 (see post of 18 October).

The specific tax issue raised by the FCA was as as follows

"One insurer offered a ‘fund of funds’. The approach to the taxation of this fund was

inconsistent – as the unrealised gains were taxed at the overarching ‘fund of fund’

level (‘top down’) whilst the realised gains were taxed at the underlying component

fund level (‘bottom up’). This meant that losses in one fund may not be offset against

gains in another and may lead to customers paying an overall higher rate of tax."

 

I would have thought that conceptually calculating tax in a fund of funds would work as follows.

•  Value the fund of funds as the sum of the price of each underlying fund multiplied by the holding.

•   Provided each underlying fund is priced net then you have effectively already allowed for tax in the fund of funds via that net price.

•  However, if the underlying funds are priced on a stand alone basis (i.e. each fund is a separate silo when making assumptions about the utilization of capital losses) then there might be a tax synergy at the fund of fund of fund level that should be reflected in the unit price

•  So say underlying fund A has realised capital gains of 10 and tax has been deducted of 2 in the unit price.

• And underlying fund B has a realised loss of 10 but has not reflected in the unit price.

•  Then at the fund of fund levels (assuming that the FOF holds 100% of both underlying) the realised capital gains position is 0 and there should a tax asset of 2 in the prIce.

The devil would be in the detail.  For instance if the gains in the example above were unrealised rather than realised then the correct answer is indeterminate as if fund A was to realise all of its gains in the current accounting period and fund B realised none of its losses in the current period then the future loss could not be set against the current gains. So how should the fund of funds tax asset re unrealised losses be valued?

 

I guess the key is to do something sensible, document the policy and have tests in place that can identify if the sensible assumption is not working out in practice..