As we reported on December 11, 2014, poorly drafted proposed legislation relating to the UK taxation of private equity executives was raising serious concerns about the future capital gains taxation of carried interest and co-investment returns. The apparent intention was to tax shares in management fees as UK source income even where they were received in some other form (such as capital gains or a loan), but the drafting seemed to go much further. Fortunately, the revised draft legislation published today reduces the potential impact of the new rules.

The scope of the provision, which can deem executives’ receipts from funds to be income, is still very broadly drafted, with no positive definition of “management fees”, but with that term instead applying to all direct or indirect receipts from the fund other than receipts falling within two excluded categories - “carried interest” and “repayment of and return on investment”. However, the breadth of these exclusions is now wider.

“Carried interest” is now defined to include, in general terms, profit-related returns to the extent they aren’t effectively guaranteed, rather than strictly requiring a return out of profits due only after the payment of a minimum 6% preferred return to investors. “Return on investment” now includes an arm’s length return reasonably comparable to that received by external investors, with the curious reference to a return equivalent to interest thankfully being dropped. These amended definitions significantly reduce the previously perceived “over-reach” of the first draft of the legislation.

A risk that non-UK tax residents would be disproportionately affected if they spent any working time in the UK has also been addressed. However, the deemed UK source of any receipt considered to be trading income under the new rule may affect non-UK domiciled UK residents claiming the remittance basis.

Despite the improvements, the rules remain difficult to apply to the typically complex structures necessitated in the private fund management industry, and a careful review of structures in place should be undertaken. The all-encompassing approach taken to the definition of “management fee” still seems likely to create unanticipated difficulties. The new rules apply to sums received on or after 6th April.