FundsThe policy of most jurisdictions is to treat the mutual fund as a company subject to corporate or income tax only on its ordinary business (i.e. net income arising from holding investments), and exempt it from taxation on its gains from buying and selling investments. In the US, provided the gains and net income are distributed, the fund does not pay federal income tax on either. Taxes are the responsibility of and paid by the shareholders under a ‘pass-through’ arrangement, whether they choose to receive cash or reinvest their entitlement.

In most other countries, distributions of capital are not permitted, except on a winding-up. If capital gains are subject to taxation, it is collected from the share and unit holders if they realise a gain when they sell their investment in the fund.

The fund may suffer other taxes in various forms in its investment and its administrative activities, both directly and indirectly. Examples are: les taxes or value added taxes on the buying of goods and services used in the administrative management of the fund; duties payable when buying or selling securities; and taxation deducted or withheld from receipts of income on investments, to the extent they are not recoverable or offset against the fund’s liability to tax.

It is usual for the fund’s activities to be distinguished according to whether they are concerned with: capital the investment portfolio (including uninvested cash) created from contributors’ capital investment, or income or net income – the income arising from the investments less the expenses of management.

Together they comprise the fund’s net asset value (NAV).

Capital

Mutual funds are normally exempted from any tax on the results of portfolio transactions, but may suffer taxes or duties applicable to the transactions themselves, in the same way as any other investor or trader in securities, e.g. contract or transfer duty. Such taxes are included in the consideration for buying securities or deducted from the proceeds of sale.

Otherwise, net capital gains from managing the portfolio of investments usually accrue within the fund entirely tax-free, provided the rate at which the fund manager makes investment changes is not excessive. Most tax authorities reserve the right to revoke a fund’s special status for tax purposes if it is adjudged that trading, rather than investment, is its purpose.

Some jurisdictions allow certain expenses of management to be deducted in whole or in part from the fund’s capital.

If this is permitted, the ability to deduct the expense from the income for tax purposes may be restricted, or else the net-of-tax value of the expense only may be taken from capital.

Income

Whether and how the net income of a fund is taxed is a function of the cash flow needs of the Government of the home country, and its attitude towards its citizens as being good at declaring their taxable income. Income should be taxed only once, either in the hands of the fund or in the hands of its ultimate beneficiaries, the share- or unit holders.

Most jurisdictions collect tax from the fund. Even the US will tax the fund if it does not satisfy the requirements for pass-through.

The basis for any tax charge reflects any tax actually (or deemed to have been) deducted, withheld or otherwise accounted for by the paying entity. For example, dividends received from companies will have been paid out of the companies’ net income after tax. Receipts of such income by mutual funds should not be subject to any further tax. Similarly, the local tax to which foreign income is subject may be reduced by the amount of any foreign tax withheld.

The general computation is as follows:

The actual taxation to be paid will be reduced by credit for foreign taxes withheld (but typically not the foreign corporation tax suffered by the paying company) where double tax agreements exist, or by an expense deduction.

Local tax rules specify which management expenses are deductible for tax purposes, and how capital expenses, such as costs of formation or of the furniture and equipment that may be part of the fund’s assets, may be amortised against net income. Normally, the tax treatment follows the accounting treatment specified within the principal regulations, but this is not always so.

Other

The other taxes that may be suffered by a mutual fund or its operator include:

  1. Gross income that has not already been fully taxed,
  2. Less Expenses of management and amortisation of capital costs allowable as cleductions for tax purposes, equals:
  3. Net income subject to taxation.ties payable on the purchase or sale of securities (e.g. stamp duty on the purchase of UK equities by UK residents).
  4. Whether or not the fund can treat such taxes or duties as credits or charges depends on local tax rules.

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MUTUAL FUNDS TAXATION REGULATION