How are hedge fund investments taxed?

Most hedge funds would be taxed under the offshore funds legislation (assuming it's based offshore) and as such your tax position would depend on whether it is a qualifying or non-qualifying fund. If it's a qualifying fund all distributions are taxed as income (ie you are paid gross and declare the receipts on your self assessment return). When you sell or extract capital a capital gain or loss will be crystallized which are taxed as normal. Therefore before April 2008 taper relief would be offset and the gain taxed at your marginal rate of tax (eg 40% if a higher rate taxpayer). After April 2008 a flat rate capital gains tax charge of 18% would be levied. If it's a 'Non-Qualifying' fund no income is distributed, and there is no liability to tax for the duration of the holding. On a disposal the gain is classed as an 'Offshore Income Gain'. The sale proceeds would then be subject to income tax and not CGT. The main difference between Distributor funds and Non-distributor funds is in the way any 'gain' on disposal is dealt with. For most UK residents a distributor would be beneficial as this would allow CGT reliefs to be offset. In particular for disposals pre April 2008 taper relief could reduce the effective tax rate to 24% for a higher rate taxpayer after 10 years ownership, and the annual exemptions (£9,200) could be offset. After April 2008 although the annual exemption (£9,600) is still available the rate of CGT is a flat 18% rate. If the fund was a non distributor fund the gain would be taxed as income (eg 40% if you were a higher rate taxpayer) unless you were non resident (or non UK domiciled, retained the proceeds abroad and paid the new £30,000 annual tax charge - if they meet the requirements).