Media Briefing Note: Taxation Benefits of Carried Interest Impacted by Finance Bill, Warn Hogan Lovells
15 July 2015
In the budget of 8th July the Chancellor announced immediate changes to the taxation of carried interest, and a consultation on the taxation of performance linked rewards paid to asset managers. The Finance Bill, published today, sets out how carried interest which arises after 8th July will be taxed.
Commenting on the changes in the Finance Bill Kevin Ashman, partner in Hogan Lovells tax practice, said:
"The effect of the legislative change is to remove the benefits of carried interest. Until now, managers have only paid tax on part (sometimes a small part) of their economic gain. In addition, HMRC is also proposing that managers will only be entitled to capital gains tax treatment (as opposed to income tax treatment) in more limited circumstances than is presently the case. The effect would be to limit capital gains tax treatment to activities which are obviously investment in HMRC's view".
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 be a chargeable gain and subject to capital gains tax. The transparency of the partnership will be disregarded for this purpose. The only permitted deductions in calculating the chargeable gain will be for the cost (or deemed cost) of acquiring the carried interest.
As a result individual investment managers will cease to benefit from the base cost shift and the ability to receive their carried interest in non-taxable form. Going forward investment managers will be taxed on the whole of their economic gains.
In addition, the ability of non-doms to benefit from the remittance basis in respect of non-UK investments will be curtailed. In the future the remittance basis will only be available to the extent the management services are performed outside the UK.
It should be noted that the other investors will continue to be taxable on capital gains calculated under capital gains tax principles which respect the transparency of the partnership. This means that the base cost shift will continue to apply as far as the investors are concerned and this may mean that UK resident investors are taxed on more than their actual gains. Some funds provide that compensating adjustments are made to such investors to compensate them for the additional tax payable. It may be necessary to reconsider compensating adjustments in the light of the changes to the taxation of carried interest of the investment managers.
On 8th July HMRC issued a consultation document on the taxation of performance linked rewards paid to asset managers. The consultation is open until 30th September. It is expected that any changes will take effect from 6th April 2016.
The government believes that individual investment managers should not automatically be able to access capital gains treatment on performance linked rewards they receive from funds. HMRC believes that investment managers should only obtain this treatment where the underlying activity is clearly an investment activity. HMRC recognise that determining whether a fund is trading or investment can be difficult and resource intensive. Instead they are proposing statutory tests which will clarify the circumstances when the managers are entitled to receive their performance related fees as capital. The tests for the investment managers will not affect the way the investors are taxed.
HMRC is proposing that all performance related fees will be taxed as income unless the fund carries on specified activities. HMRC is considering two way of achieving this.
Option 1 would list particular activities which are, in the government's view, clearly investment activity
• Controlling equity stakes in trading companies intended to be held for a period of 3 years
• The holding of real property for rental income and capital growth where, at the point of acquisition, it is reasonable that the property will be held for at least 5 years
• The purchase of debt instruments where, at the point of acquisition, it is reasonable to suppose that that the debt will last for at least 3 years
• Equity and debt investments in venture capital companies, provided they are intended to be held for a specified period of time.
Option 2 would focus on the length of time for which the underlying assets are held. HHRC are proposing a graduated system so that if investments were held for less than 6 months the whole of the gain would taxable as income; if investments were held for between 6 and 12 months 75% of the gain would be taxable as income; if the investments were held for between 12 months and 18 months 50% of the gain would be taxable as income; if the investments were held for between 18 and 24 months 25% of the gain would be taxable as income; and if the investments were held for more than 24 months none of the gain would be taxable as income.
HMRC is inviting comment on both options. Looking at the proposals it seems to us that there is considerable scope for effective lobbying.