The Investment Manager Exemption (“IME”) is a long standing statutory concession which was introduced for the benefit of UK managers of offshore funds (in particular hedge funds). The exemption operates to prevent a UK investment manager constituting a UK representative of a non-resident person and, therefore, subjecting that non-resident person’s profits to UK tax. The IME has been an important tool in ensuring that the UK is a globally competitive jurisdiction out of which investment and fund managers can operate.

The past couple of years have seen a number of amendments to the legislation governing the IME and the associated guidance. These changes have been both fundamental and clarificatory. At the time it was announced that changes would be made to the IME there was significant concern that the amendments would lead to less certainty resulting in investment managers moving offshore.

Is the exemption relevant to you?

The exemption is only relevant if the activities of the offshore fund amount to trading. If the fund is making long-term investments, it will not normally be subject to UK tax on its profits even if its assets are bought and sold by a UK manager. However, if the transactions amount to trading (for example, active buying and selling of assets which are owned for a short period and yield no income such as dividends), and the transactions are carried out in the UK through a UK investment manager or agent, the profits are subject to UK tax which can be assessed on, and recovered from, the agent. It is in these circumstances that the IME may be relevant.

Do you pass the test?

In order to qualify for the exemption, an investment manager must satisfy a number of conditions. These conditions are essentially aimed at ensuring that the manager is providing bona fide investment management services in the ordinary course of its business and that it is doing so on normal commercial terms. As a result, the manager must be undertaking investment transactions on behalf of the non-resident person in an independent capacity and must be paid an arm’s length fee for doing so. The manager (and persons connected with him) must not have more than a 20 per cent beneficial entitlement to income of the non-resident person. However, if this 20 per cent rule is breached the IME will still apply to that income to which the manager (and connected persons) does not have an entitlement so that it does not become subject to UK tax.

Prior to 2008 the IME did not apply if the manager undertook any investment transactions on behalf of the non-resident which did not qualify for the IME. This has now been changed so that for accounting periods ending on or after 21 July 2008, if a manager undertakes non-qualifying transactions the IME can still apply to those transactions which do qualify, ensuring that income and profits arising from the qualifying transactions are not subject to UK tax. This was a welcome change as it allows the IME to operate in a greater range of circumstances and is a more proportionate application of the exemption.

Are you independent?

In determining whether an investment manager is acting in an independent capacity, consideration should be given to HMRC’s Statement of Practice 1/01. Prior to its amendment in July 2007 the statement provided that if the investment manager satisfied one of a number of conditions it would be considered independent. This provided certainty for investment managers as they would be assured that if they fell within one of these ‘safe harbours’ the IME would apply. The Statement of Practice was, however, amended to introduce a hierarchy of conditions. The result of this is that if a fund is either widely held (broadly, no majority interest in the fund is held by five or fewer people or no single person holds more than a 20 per cent interest in the fund) or actively marketed (that is there are genuine ongoing attempts to market the fund and achieve third party investment) the investment manager will be deemed to be independent. If the fund is not widely held and is not actively marketed, the manager will still be deemed to be independent if the provision of services to the non-resident person (and connected persons) does not form more than 70 per cent of the investment manager’s overall business. If none of these tests is satisfied, wider consideration must be given to all of the circumstances relating to the relationship between the investment manager and non-resident person. It could be argued, therefore, that unless a fund is widely held, actively marketed or the 70 per cent test is met, a degree of certainty has been lost. However, it would appear that the impact of this has not been as great as was originally anticipated and the majority of funds should continue to satisfy one of these three tests.  

Investment transactions

The latest change to the IME is the publication of the draft Investment Manager (Specified Transactions) Regulations 2009 (the Regulations) in March this year which set out those investment transactions that may qualify under the IME. Prior to the Finance Act 2008 a short definition of investment transaction was contained in the legislation with regulations extending this to cover financial swap transactions. The Finance Act 2008 set the path for an amended definition by introducing legislation enabling the Regulations to apply, the aim of which was to bring the range of qualifying investment transactions in line with those activities regulated by the Financial Services Authority. An investment transaction which may qualify under the IME will be one which falls within these Regulations.  

The Regulations contain greater detail than many expected and are, therefore, arguably welcome in providing the much desired certainty sought by the industry. Those transactions which were previously contained in the old definition and supplementary regulations, such as transactions in shares, securities, buying and selling foreign currency and carbon emission trading products, have been retained.

Transactions in futures contracts, options contracts and contracts for differences have also been retained but the Regulations provide greater detail on those transactions which will qualify and make it clear that, if such a contract results in the physical delivery of property which is not covered by another head within the Regulations, they will not qualify.

Previously “investment transactions” included the placing of money at interest; this has now been extended so that a wider range of loan relationships will qualify. Debentures, transactions where an exchange gain or loss arises to the non-resident person and transactions involving the disposal of an existing debt will all now qualify.

Finally, the Regulations have introduced a new head under which a transaction can qualify as an investment transaction; transactions in units in collective investment schemes (broadly, arrangements enabling people to participate in or receive profits or income from the holding, management or disposal of property and in which the participants do not have day to day control over the management of the property) now fall within the IME.

Whilst the consultation period in respect of these draft Regulations ended on 27 March 2009, they are, at the time of writing, still in draft form and may, therefore, be subject to change.


Contrary to expectation, the changes made to the IME over the past two years do not appear to have prejudiced certainty over whether the IME will apply in certain situations, in fact, in some respects there is greater certainty. This is to be welcomed when we have recently seen a number of companies move out of the UK to avoid what is perceived as an increasingly uncompetitive and uncertain tax environment.

It is worth noting that the amended provisions in the Statement of Practice will apply from 1 January 2010 to all investment transactions entered into prior to 20 July 2007. As we are approaching the end of the transitional period it is important for funds that have not already done so to consider whether any contractual relationship with investment managers requires amendment in order to retain the benefit of the IME.