Finance Bill
2015
Disguised fee income
UK issues draft legislation for consultation on the taxation of
fees for fund management services and carried interest
returns
The Chancellor’s 2014 Autumn Statement included an announcement that the UK Government
intended to introduce anti-avoidance measures to counteract arrangements that avoid amounts
arising to investment fund managers for their services being charged to income tax. The
publication of draft clauses for inclusion in Finance Bill 2015 on 10 December has provided more
details on these measures.
The Government’s stated objective is to exclude carried interest (incentive allocations) and coinvestment from these rules. However, there is a very broad definition of ‘management fees’ which
includes performance related incentives and fees combined with a very narrow safe harbour for
carried interest and certain investment returns. The definition of ‘carried interest’ in the draft
legislation means that the arrangements employed by many funds would fall outside this
exemption and therefore such investment returns will be charged to income tax and National
Insurance contributions (NICs).
There are further complications for fund managers that conduct some of their activities (such as
marketing) offshore. Depending on the circumstances, all profits from these offshore activities
could be treated as wholly taking place in the UK with the consequence that those individuals
become liable to income tax and NICs on the entire profits of the business, unless a double tax
treaty applies to protect the individual.
It is intended the final legislation will have effect on all ‘disguised fees’ arising on or after 6 April
2015, whenever the arrangements were entered into.
What arrangements are the Government
seeking to counteract?
Generally, sums for the provision of investment
management services, as opposed to performance
rewards, were charged to tax as income. However, the
Government has indicated that it believes structures have
increasingly been used by private equity firms in which
annual fees are paid as priority partnership shares to
avoid an income tax charge on the fees. It is these
arrangements that the Government has indicated that it
intends to counteract.
Importantly, the Government has stated that it is not
seeking to tax carried interest or co-invest arrangements
as disguised fee arrangements. However, as drafted, the
proposed legislation may miss its policy objective and
may result in investment managers being subject to tax
on their carry and co-investment arrangements as UK
trading income.
The Government is seeking to raise £360m of tax revenue
by 2020 by introducing measures as part of Finance Bill
2015 that charge amounts arising to individuals to
income tax and NIC where:
► they are performing investment management
services for funds
► any part of the relevant service is performed in the
UK
► partnerships are involved, and
► they are, by virtue of their services, entitled to
amounts, directly, or indirectly, which are not
otherwise chargeable to income tax or exempted.
Where the rules apply, it is intended that these ‘disguised
fees’ are charged to income tax as trading income as if
the individual were conducting a trade in the UK.
Which carried interest arrangements are
likely to be affected?
The draft legislation includes exemptions for carried
interest returns that it appears are intended for funds
that operate ‘fund as a whole’ or ‘deal by deal’ carry.
However, both exemption measures require investors:
►
►
Many may find that they are unable to meet the definition
as their commercial arrangement with their investors
results in a preferred return of less than 6% per annum
and/or does not provide for the return of all invested
amounts to investors before the carried interest
allocation.
What are the other concerns for fund
managers?
In addition to the issues raised above, we have further
concerns that the draft legislation appears to have a
number of wide reaching and possibly unintended
consequences for the investment management industry.
As part of the consultation process, we will be seeking
urgent clarification from HM Treasury and HMRC on the
following points:
1.
2.
The legislation could result in amounts paid to
offshore entities for investment management
services (under OECD compliant transfer pricing
principles) becoming wholly taxable in the UK if
any part of that activity is performed in the UK,
even if the fees are in line with OECD transfer
pricing.
The safe harbour for co-investment may be
construed to be limited to the return of the
investment principal and require any further return
to be reasonably comparable to a commercial rate
of interest. Accordingly, it would seem most
shares or interests in funds held by the investment
management team, with or without discounted fee
arrangements, may be treated as disguised fees
and taxable as UK trading income.
What should the fund management
industry be doing now?
The investment management industry is invited to submit
representations as part of the consultation process.
Whilst we will be raising our concerns directly with HM
Treasury, we would recommend that those affected may
wish to consider making similar comments. In addition to
feeding into the consultation process, fund managers may
wish to review their existing fund structures to determine
how they might be affected by the proposed changes.
to have all or substantially all of their investment
returned or repaid to them from either the whole
fund (in the case of fund as a whole) or the relevant
investments (in the case of deal by deal),
and each investor to have received a preferred
return of at least 6% per annum.
The narrow definition of the carried interest exemption is
likely to present a problem for many incentive allocation
and carry arrangements.
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