Offshore Bond Funds

I wanted to follow up on my post of 22 January on the draft finance bill clauses dealing with the bond fund regime.

What I’m interested in is the correct treatment of an offshore fund that is over 60% invested in loan relationships? (described in what follows as an offshore bond fund)  My concern is with the existing legislation and not the changes. 

It was always my understanding of the legislation that distributions from an offshore bond fund received by a company were taxable as loan relationship credits by virtue of CTA 2009 490 and CTA 2009 307 3 (a). 

CTA 2009 490 (4) excludes from the loan relationship legislation distributions, other than interest distributions, from an AIF, but that does not include an offshore fund (because it’s not an AIF).

Taxing bond fund distributions under the loan relationship legislation seems sensible and is in line with HMRC’s guidance in CFM 43050 that  says;

“ Interest distributions made by an AIF to a company unit holder whose holding is treated as a loan relationship are brought in to account when they are due and payable but no other distributions of an AIF are to be taken into account. This is because the corporate streaming rules already bring into corporation tax relevant amounts of dividend distributions from UK authorised funds.
Otherwise, all income (my italics) arising from a corporate holding in a unit trust, offshore fund or OEIC that is treated as a creditor relationship will be regarded as a loan relationship credit or debit as well as the relevant and the fair value movement in the value of the holding.”

But I'm wondering whether HMRC and I have got this right?  What seems to cause a problem is CTA 2009 section 465 (1).  This reads:

“Credits or debits relating to any amount falling, when paid, to be treated as a distribution must not be brought into account for the purposes of this Part (i.e. loan relationships), except, in the case of credits, so far as they are avoidance arrangement amounts (see subsection (4)).”

The wording here is not clear, but I would read it as saying that distributions cannot be taxed under the loan relationship regime.  CTA 2009 465 (3) then excludes from 465 (1) certain distributions that are taxable as loan relationships but the list does not include distributions paid by offshore bond funds .  

So whilst common sense might dictate that offshore bond fund distributions be taxed under the loan relationship legislation the strict wording of the legislation is, in my opinion, that such amounts are exempt. 

Bond fund distributions are, however, excluded from 465 (1), in 465 (3) of the draft changes to the legislation so this potential issue only arises pre - Finance Bill 2014..

It would be interesting to know  whether life insurance companies are taking this point up with HMRC and whether HMRC have made any comments during the bond fund consultation process.