Along with the wide ranging anti-avoidance rules surrounding disguised investment management fees that came out of the Chancellor’s Autumn Statement last December, and were implemented from 6 April 2015 – follow this link to read more – there were two further legislative changes that were less publicised by the July 2015 UK Budget which will affect the Private Equity and Investment Management industries.
First, an item included in the July Budget was the ending of the base-cost shift on transactions post 8 July 2015. This would often substantially reduce the taxable amount of carried interest chargeable to capital gains tax. Prior to this, a carried interest participator would usually pay a minimal amount for their carried interest rights and therefore contribute a negligible amount towards the acquisition cost of fund assets.
However, on sale of the fund’s assets, when calculating the capital gains arising thereon and allocating them to the various interested parties, the carried interest members would have benefitted from sharing in the original cost basis of those assets. Going forward, carried interest members will only be able to share in the cost base to the extent of their actual capital contribution, which in practice will mean their capital gain for tax purposes will be similar to their share of proceeds from the transaction. This treatment is more in alignment with the US taxation of carried interest returns.
Second, an intent to charge carried interest to capital gains tax in the UK to the extent it relates to services performed in the UK. Going forward, rules surrounding foreign chargeable gains received as carried interest have been changed so that they are only eligible for taxation on the remittance basis to the extent the individual performs the relevant investment management services offshore. In other words, UK resident non-domiciled fund managers will no longer be able to shelter their carried interest from UK capital gains tax using the remittance basis and section 12, TCGA 1992, which defined foreign chargeable gains by reference to the location of the assets disposed of. Instead, carried interest generated by UK resident non-domiciled fund managers will be charged to UK CGT in the year that it arises, and to the extent it relates to services performed in the UK. The intention behind these changes is to ensure that carried interest holders pay their fair share of tax in the UK whereby they are taxable on the amounts they actually become entitled to in relation to corresponding services performed in the UK.
There are to be provisions that allow the gains to be apportioned between the UK and offshore where the fund manager performs some of the investment management services offshore. However, many fund managers will be required to perform their duties within the UK in accordance to their employment contracts, and thus may not be able to take advantage of these provisions.
It is also likely to be difficult to avoid the mixed fund rules associated with remittances to the UK where an element of the carried interest is sourced to the UK and an element is sourced offshore. This would mean that despite being taxed on the UK portion of the carried interest, it may be difficult to bring the UK taxed funds onshore as the foreign element will be deemed to have been remitted to the UK first.