Out-Law News 2 min. read
08 Jul 2015, 4:55 pm
From today, individuals involved in the management of private equity funds and other investment funds who receive a payment known as "carried interest" will no longer be able to rely on the accounting treatment applying to assets held in a limited partnership to reduce the effective rate of capital gains tax payable.
An investment fund manager who participates in the funds structure using limited partnership vehicles often receives an interest in the fund known as carried interest, which is linked to the performance of the fund. Until today the applicable accounting treatment when funds went into "carry", known as the "base cost shift" would generally apply to treat much of the carried interest return received as a return of the original partnership capital, and thus to reduce the capital gains tax paid on carried interest.
Funds tax expert Tom Cartwright of Pinsent Masons, the law firm behind Outlaw.com, said that today's changes will "have a fundamental impact on the private funds management industry."
He said that "the beneficial treatment afforded to the taxation of carried interest in limited partnerships was well known to HMRC for many years." Cartwright was "disappointed" that such "a fundamental change should take place immediately with no grandfathering for existing arrangements.”
"The ability of fund executives to treat much of their carried interest return as a return of capital for tax purposes gave them very beneficial treatment," Cartwright said. He added that "the removal of this benefit may lead to a review of existing fund structures to consider other types of vehicle.”
Investment funds expert Daniel Greenaway, also of Pinsent Masons, said that "on the basis of the announcement it is clear that this will affect holders of carry in mezzanine and debt funds as well as in private equity funds; this, together with the changes to the non-dom rules, will undoubtedly mean that teams will look to review the structure of their carried interest".
Documentation published today reveals that the proposed changes will not affect "genuine coinvestments" in funds made by managers on an arm's length basis.
Today's changes to carried interest follow new rules introduced as part of the 2015 Finance Act designed to ensure that sums received by individuals who are partners in firms that manage investments pay income tax rather than capital gains tax on amounts, which are "disguised" investment management fees. Those rules were made to target structures used by private equity firms, in particular, where annual fees were paid as priority profit partnership shares to avoid an income tax charge on the fees.
Cartwright predicted that "it is possible that, due to the plethora of anti-avoidance measures now aimed at limited partnership fund structures, other types of vehicle will become more popular.”
Greenaway added that "as well as affecting the structures of new funds, some teams will benefit from restructuring the entire fund and not just the carry vehicle. This could be possible depending on the drafting of the LPA. Having said that management may be reticent to approach investors for a restructuring that has no upside for those investors"
HMRC also published a consultation to better understand the activities of collective investment schemes (18-page / 413KB PDF), with the ultimate aim of determining when performance returns should be taxed as capital gains. It is not currently anticipated that this will lead to changes to the tax treatment of carried interest.
Cartwright said that "it is clear that HMRC will be considering whether some returns in the funds industry should be treated as akin to remuneration and subject to the higher rates of income tax".
