On July 8, the Right Honourable George Osborne MP, Chancellor of the Exchequer, introduced measures in his Summer Budget to abolish what is commonly known as the “base cost shift” as applied to sums received by individuals based in the United Kingdom involved in the investment management of private equity and other investment funds structured as partnerships, which is linked to the successful performance of a fund (carried interest); the stated purpose of such new measures being, to “make the tax system fairer by ensuring that individuals to whom a gain arises in the form of carried interest are taxed on their true, economic gain and that planning tools designed to ensure they are taxed on a lower figure, to achieve a lower effective rate of tax, are not effective.”
Historically, the application of capital gains tax to carried interest following the disposition of an asset by a partnership was calculated in accordance with Statement of Practice D12 (D12) published by Her Majesty’s Revenue and Customs (HMRC), which set out an agreed-upon interpretation of how the relevant tax legislation on chargeable gains should be applied. However, the application of D12 (together with tax planning techniques) could result in the relevant investment professionals being charged capital gains tax on amounts that were significantly less than their actual economic returns.
As a consequence of the changes implemented in the Summer Budget, D12 has been superseded and new legislation is to be introduced (New Legislation) so that in circumstances now where an individual performs investment management services for a collective investment scheme through an arrangement involving one or more partnerships, then the entire sum received by them in respect of carried interest under that arrangement will constitute a chargeable gain and be subject to capital gains tax at 28 percent (so that individuals are liable for tax on their actual profit). Under the New Legislation, deductions will only be allowed in calculating chargeable gains with respect to sums actually invested in the fund structure by individuals as consideration for acquiring the rights to that carried interest (as opposed to the amount that would have been permitted under D12). The New Legislation also provides that carried interest will only be construed as a foreign chargeable gain (and hence outside the scope of UK tax) for non-UK domiciled (but UK tax resident) individuals only to the extent that the recipient of the carried interest performed their services outside of the United Kingdom. The New Legislation does however give credit for employment income tax charges (where relevant). The New Legislation will not affect co-investment arrangements with funds made by investment managers on an arm’s length basis or the taxation of performance-linked rewards.
The New Legislation will be incorporated in the Finance Bill 2015, which will introduce new sections in the Taxation of Chargeable Gains Act 1992. It will have effect from July 8, on all carried interest, irrespective of when the arrangements were entered into so there are no grandfathering provisions applicable.
A tax impact note (together with draft legislation to implement the foregoing) can be found here.