In last week’s Autumn Statement, the UK government announced a new rule which was understood to be targeting investment management firms achieving UK capital gains tax treatment for interests in guaranteed investment management fees for participating individuals. The structure under apparent scrutiny was the streaming of priority shares of a fund’s investment income and gains to individuals through tax-transparent partnerships, as an alternative to the simple payment of a management fee, which would be taxable as income. Taxpayers’ concerns were initially soothed by the explicit promise that individuals’ investment returns and shares in carried interest would not be affected.
Unfortunately, the detailed draft legislation unveiled this week appears to be of potentially wider application. This may be intended or inadvertent, or a mixture of both. The apparent “over-reach” arises because, rather than, as would be expected, using a positive definition of the targeted “guaranteed management fees”, the draft instead defines the terms “carried interest” and “investment return” narrowly, then providing that everything else is deemed to be a “management fee”. It seems the draftsman is not confident enough as to what the targeted “management fees” are so as to be able to actually define them. Simplifying:
- ”management fee” is defined to encompass all sums arising from a fund, unless they constitute either “carried interest” or a return of, or on, an investment made by the individual;
- ”carried interest” is then defined restrictively, as being payments made “out of profits” after investors have received the repayment of their initial investment plus a preferred return, which must be at least 6% compounded; and
- ”return on investment” is then defined, surprisingly, as a return reasonably comparable to a commercial rate of interest.
Income tax may be due on “management fees” as so defined, where they “arise” directly or indirectly to an individual and they are “untaxed” (meaning not taxed as employment income of, or brought into account in a trading computation of, the individual). “Arising” appears to mean the actual receipt of money’s worth. For the charge to apply, the fee must arise to the individual under arrangements through which the individual is performing (directly or indirectly) investment management services (defined widely, of course, to include fund raising, researching, acquiring, managing and disposing of investments) for the relevant fund, and which involve at least one partnership. Receipts caught by the rules are taxed as trading income, and are also deemed to be UK source if any of the investment management activities are performed in the UK.
It is to be hoped that the apparent requirement for investment returns not to exceed a return comparable to commercial interest in order to be excluded from scope can be clarified, so that normal course investment returns are not classed as “management fees”. It is also to be hoped that clarification will be forthcoming such that shifted basis, although not necessarily “profit”, should be treated as “carried interest,” and not as a management fee. Another area of uncertainty is the scope of the “arrangements” through which the services are provided. If an individual participates in a separate co-investment vehicle, is that outside the relevant “arrangements,” and so outside the scope of this new provision? There is also a concern that the potential treatment of the deemed trading income as UK source could have an impact for non-residents unless the draft rules are refined.
The new rules are expected to apply from 6th April 2015. It is to be hoped that the consultation process will deliver the necessary clarifications. It is likely to be advisable to await further developments before considering any immediate restructuring.