There were lots of surprises in the UK’s post-election “Summer Budget”, just announced, and most were unwelcome. The headlines for the private equity industry are as follows.
Carried Interest and Performance Related Rewards
Nearly 30 years after base cost shift for carried interest holders was enshrined in a 1987 Memorandum of Understanding between HM Revenue & Customs and the British Venture Capital Association, it was brutally killed off by the Chancellor today. For carry proceeds arising from today (8th July) forward, only an executive’s own cost of investment will be allowable in the computation of gain. Additionally, there will also be a consultation on possible changes to the taxation of “performance linked rewards” (such as carry), deeming income treatment in certain circumstances. In order for capital treatment to apply to asset managers’ performance linked rewards in the future, the underlying fund may need to satisfy defined criteria which demarcate the fund as effectively a passive investment fund, rather than an active trading fund. The concept is that traditional private equity carried interest’s capital treatment should not be affected, with only rewards arising from hedge-type activity affected. However, the danger is, as with the recent “disguised investment management fees” proposals, that HMRC’s suggested approach appears to be firstly to assume that all performance linked rewards are income, not capital, but to then exclude rewards from funds with defined activities considered to be longer-term activities, which remain capital. The problem will be in defining the exclusions, which if too narrow could result in unexpected income taxation for some managers’ carry. For example, there is a reference to an exclusion for funds investing in secondary debt markets for an intended three-year term, but no reference to debt origination, whatever the intended term. Hopefully the consultation process can be a productive one before the introduction of this measure, which is anticipated for 6 April 2016.
Non-UK Domiciled Individuals
UK resident but “non-UK domiciled” individuals’ ability to benefit from the remittance basis, permitting non-UK taxation of non-UK source income and gains, is to be withdrawn for individuals who have been UK resident for 15 out of 20 years, with effect from April 2017. Such individuals would then be subject to UK tax on their worldwide income and gains. The change could obviously negatively impact many long-term UK resident non-UK nationals in the industry.
Taxation of Dividends
The effective personal income tax rate on dividend income is to be significantly increased, to a maximum rate of 38.1% (against a current effective top rate of 30.55%), from April 2016. However, an individual’s first £5,000 of dividends is to be tax free. This will significantly impact executives in receipt of fund or management related dividend income.
Corporation Tax Rate
The UK’s corporation tax rate, currently 20%, will be cut to 19% in 2017 and 18% in 2020. This is a very eye-catching rate for a developed economy.
Loss of Tax Depreciation on Goodwill
With consequences for deal structuring, future acquisitions of business assets including goodwill will not generate an entitlement to tax depreciation allowances on the goodwill. This brings asset deals into alignment with stock deals in this respect.