An immediate tax impact on fund managers
A special tax treatment that was originally agreed with the investment industry in 1987 and formalised by HMRC under Statement of Practice D12, was overturned in Wednesday's budget, raising an estimated £1.8bn for the exchequer from the private equity and venture capital industry over the next five fiscal years.
The measure relates to the treatment of 'carried interest', the performance element paid to fund managers upon the successful disposal of investments. Any such gains arising on or after 8th July 2015 will be calculated under the new provisions, irrespective of when the original arrangements were entered into. The old rules enabled a shifting of the base cost in investment partnerships from the investors to the fund managers. This allowed fund managers to substantially reduce the calculation of the chargeable gains arising on their carried interest, despite the fact that they had not actually invested any cash.
The good news is that the treasury accepted the argument that carried interest should remain taxable as a capital gain. Legislation that was introduced in April this year closed a loophole that allowed private equity firms to treat management fees as capital gains and they are now taxed as income.
The proposed legislation, to be written into the recent disguised investment management fee rules will confirm that "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 will constitute a chargeable gain".
Only specified sums will be allowable as a deduction against the sum received when calculating the chargeable gain "to ensure that individuals are charged to tax on their true economic profit". In particular, a deduction will only be allowed for consideration actually paid by the individual rather than any notional sum previously allowed.
The result is that investment managers will from now on be paying capital gains tax (currently 28%, or 10% if Entrepreneur's Relief applies to the disposal) on the whole of their carried interest. The treasury estimates that the measure will have an impact on several thousand individuals in private equity firms or elsewhere in the investment management sector.