The government announced that it would consult to understand the trading and investment activities performed by collective investment schemes. The consultation aims to ensure that individuals who manage funds where the underlying activities are trading rather than investing, pay full income tax on any performance fees they receive.
Whilst committed to maintaining the current tax treatment of some performance related rewards (for example the CGT treatment of carried interests in private equity funds), the government is concerned by the number of asset managers who have restructured their performance fees (typically a reward for services and taxed as income) as performance linked interests in the underlying funds so that those fees obtain the same tax treatment as carried interest.
The government proposes to introduce a specific tax regime which will ensure that individuals are taxed ‘appropriately’ in light of the underlying activity of the investment vehicle. If the fund is trading, the profits of the individual managers should be taxed as income, however if the fund is a longer term investment fund, then the returns to the manager may be capital in nature and taxed as chargeable gains. The proposed rules will only apply to performance linked rewards paid to investment managers. They will not apply to any genuine co-investment in the fund on an arm’s length basis or on the treatment of the investment vehicle or investors.
The approach proposed in the document is to establish a default rule that all performance linked rewards paid to an individual performing investment management services are charged to tax as income. However, there will be a carve-out for performance linked interests in vehicles that will be subject to capital gains tax where they undertake specified activities. It is expected that private equity carried interest will continue to be taxed as a gain, though that is dependent upon the investment strategy of the fund. The government is seeking comments on two options for determining whether capital gains tax treatment should apply:
- Option 1: This would list particular activities which are clearly investment in nature and would be charged to tax as chargeable gains subject to certain conditions. Examples given are controlling equity stakes in trading companies intended to be held for at least three years, holdings of real property where the property is expected to be held for more than five years, secondary market debt instruments held for three years and investments in venture capital companies held for a specified time.
This option would focus on the average length of time for which the fund holds investments with a graduated system for determining which proportion of the return is eligible for taxation as chargeable gain. This would range from 0% for investments held for less than six months increasing by 25% increments up to 100% for an average investment period of over two years.
The consultation period runs from 8 July 2015 to 30 September 2015 with draft legislation expected to be published with the Autumn Statement 2015 with a commencement date of April 2016.
Business tax team