In today’s Summer Budget, Chancellor George Osborne has announced measures which have the effect of immediately removing the “base cost shift” which has, up until now, allowed investment fund managers’ “carried interest” to be taxed at effective rates of capital gains tax below the normal rates. In addition, a consultation has been launched on the taxation of performance-linked rewards for investment managers with a view to limiting the circumstances in which such rewards can be taxed as capital rather than income. This is a further and unwelcome radical reform to the taxation of fund managers and to long-standing practice in the industry and follows close on the heels of the recent disguised investment management fees rules.



Private equity and other investment funds are commonly structured using partnerships (including limited liability partnerships), so that the performance- linked element of the managers’ reward (often called the “carried interest”) is subject to capital gains tax rather than income tax. A feature of this structuring is typically a capital gains “base cost shift”, whereby the relevant managers’ capital gains base cost is treated for tax purposes as exceeding the amounts they have actually paid for their carried interest. The effect of this is that the managers pay an effective rate of tax on their carried interest which is below the main rate of capital gains tax.

Measures having effect from today

The Chancellor has announced that, with effect from today, where an individual performs investment management services for a collective investment scheme, through an arrangement involving one or more partnerships, then any sums received in respect of carried interest under that arrangement will constitute a chargeable gain and be subject to capital gains tax. For these purposes, carried interest will be defined by reference to the disguised investment management fee legislation introduced in April. Only specified sums will be allowable as a deduction against the sum received when calculating the chargeable gain. In particular, a deduction will only be allowed for consideration actually given by the individual (if any) in return for the carried interest. It is clear from the announcement that these measures are specifically targeted at the base cost shift. This will clearly affect fund managers’ projected returns and is likely to affect structuring.

These measures will have effect for all carried interest arising on or after today, whenever the arrangements were entered into. It will therefore be important that the relevant implementing legislation is circulated and finalised as soon as possible.

The Budget documents say that the new rules will treat any sums received in respect of carried interest as capital gains. Where the legal form of these sums is actually something other than capital gain (such as dividends or interest), this would appear to mean that the relevant manager could potentially benefit from the lower rates of capital gains tax (as compared to income tax). It seems unlikely that this is the Government’s intention, but is another reason why it will be important to see the implementing legislation.


Separately, the Chancellor has also launched a consultation with a view to introducing, from 6 April 2016, a specific tax regime for performance-linked rewards paid to individuals performing investment management. This follows on from April’s disguised investment management fee legislation, which dealt with the “management fee” element of investment fund managers’ rewards.

The consultation document says that the overarching approach of the new legislation will be to establish a default rule that all performance-linked rewards paid to a relevant individual are charged to tax as income, subject to exceptions which will depend on the activities carried on by the relevant fund. The consultation appears to suggest that capital gains treatment will depend on the extent to which the fund carries out investment (rather than trading) activities. The Government expects that private equity carried interest will continue to be subject to capital gains tax, though that will be dependent upon the strategy of the fund. It is not clear whether the new legislation will be limited to structures involving partnerships.

It will be important that the exceptions from the proposed default rule that performance fees are subject to income tax are clearly defined and the fund management industry will be looking for comfort that the tax treatment of normal carried interest arrangements will not be impacted.