The Summer Budget 2015 contains a number of measures effecting those in the financial services sector including the taxation of carried interest, introduction of a new bank surcharge and significant changes to the non-dom regime.
Asset management firms
Taxation of carried interest entitlement
With effect from 8 July 2015, individuals involved in investment management for private equity or other funds who receive a carried interest linked to the successful performance of the fund, will be chargeable to capital gains tax (CGT) on the full economic value they receive.
Carried interest arises from an individual’s participation in an investment vehicle, typically a limited partnership. Whilst the carried interest entitlement has always been subject to CGT rather than income tax, through the operation of the tax legislation as it has been applied to partnerships, individuals have been able to secure a tax deduction against their carried interest entitlement which was higher than the consideration given by the individual for their interest.
Where a chargeable asset held by the partnership is disposed of, the tax legislation treats the gain as accruing to the individual in accordance with their capital share in the partnership. Historically, this has meant that in calculating an individual’s taxable carried interest, a deduction is available for a share of the cost of acquisition of the asset incurred by the partnership. The changes announced in the Summer Budget will restrict the deduction available to the individual to the consideration actually paid by them (if any) for the carried interest. No deduction will be available for the proportionate share of the cost of the asset to the partnership, which has commonly been referred to as a ‘base-cost shift’.
These changes are likely to have a significant impact on the post-tax returns of private equity and other investment fund managers and we expect to see such funds looking to restructure their funding models. The measures will not affect genuine investments in funds made by managers on an arm’s length basis, known as ‘co-invest’ and provisions will also be made to ensure that credit is given for employment income tax charges where relevant.
Consultation on the taxation of performance linked rewards paid to asset managers
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 CGT 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 CGT treatment should apply.
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 a 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.
Limited partnership consultation
It was announced that the government will publish a consultation on technical changes to limited partnership legislation to enable private equity and venture capital investment funds to make more effective use of the limited partnership structure. Further details will be available once the consultation document is published.
Stamp Duty Land Tax (SDLT): application to certain authorised property funds
As previously announced, the government intends to introduce a seeding relief for Property Authorised Investment Funds (PAIFs) and Co-ownership Authorised Contractual Schemes (CoACSs) and intends to make changes to the SDLT treatment of CoACSs investing in property so that SDLT does not arise on the transactions in units, subject to the resolution of potential avoidance issues.
Changes to the taxation of dividends
The Chancellor announced a major overhaul of the taxation of individuals receiving dividends. Currently, a tax credit of 10% of the gross dividend is available, with dividend tax rates of 10% for basic rate taxpayers, 32.5% for higher rate and 42.5% for additional rate taxpayers.
Under new rules applying from 6 April 2016, the government will abolish the dividend tax credit and replace it with a new dividend tax-free allowance of £5,000 per year. Dividend income above that amount will then be charged at 7.5% for basic rate taxpayers, 32.5% for higher rate and 38.1% for additional rate.
When announcing these changes, the Chancellor claimed that these changes were driven with the aim of making the dividend tax regime fairer. However, government figures indicate that the Chancellor expects this change to be one of the highest revenue raisers of the Budget, increasing receipts by £2,540m in 2016/17 with further substantial increase in most years bar one for the rest of the current Parliament.
Major changes to non-dom regime
The Chancellor has announced wide ranging changes to the taxation of UK resident non-UK domiciliaries. These announcements are short on detail. A consultation on the changes will be published in the autumn, and the new rules will form part of the Finance Bill 2016 and apply from 6 April 2017.
What we do know
UK resident non-doms will be deemed domiciled for income tax and CGT purposes after 15 years of residence, and will pay tax on their worldwide income and gains in the tax year in which the income or gains arise. This rule will also apply to inheritance tax. There is already a deemed domicile rule for inheritance tax but this applied where someone had been resident for more than 16 out of the previous 20 years of assessment. The new rule shortens this period by a year.
There will be no grandfathering provisions, so these rules will apply regardless of when someone came to the UK. However, the old regime will continue to apply where an individual leaves the UK before 6 April 2017. It will only be possible to break deemed domicile status by ceasing to be resident in the UK for at least five tax years.
This means that the recently introduced £90,000 remittance basis charge (RBC) for residence of more than 17 out of 20 tax years will not apply from 2017/18, as individuals will now be deemed UK domiciled at that point. A result of this is that the proposal to elect into the remittance basis for tranches of three years has been scrapped. The £30,000 and £60,000 RBC rates will continue to apply.
The potential good news is that non-doms who have set up an offshore trust before they become deemed domiciled in the UK may not be taxed on trust income and gains that are retained in the trust and the assets will remain outside the scope of inheritance tax (unless the assets concerned are UK residential property). However, there will be detailed consultation on the new rules as it is recognised that this will be a significant change to a complex area of law.
It also seems that these rules do affect an individual’s domicile status under general law so that an individual may continue to pass their non-domicile status on to their children.
- There will be a period of consultation followed by draft legislation. You can rest assured that Moore Stephens will be actively involved.
- There is time to plan. The provisions are not introduced until 6 April 2017.
- Some of the proposals in relation to offshore trusts appear to be helpful and better than the current rules, although it is too early to be sure of the detail.
The statutory residence test can allow an individual to spend a reasonable amount of time in the UK whilst knowing with certainty they are not resident.
Levy and surcharge
The special levy on banks introduced in 2010 has drawn increasing criticism from within the industry, with some well-known participants publicly announcing reviews of whether to retain their UK headquarters.
The bank levy is based not on the profitability of the institution but on the total value of its equity and liabilities. It is thus not directly geared to its trading performance.
In response, the Chancellor has committed to reducing the levy progressively each year until 2021. The immediate change is a reduction in the rate charged on short term liabilities from 0.21% to 0.18% with effect from 1 January 2016 (with a proportionate reduction in the rate attributable to equity and long-term liabilities).
At the same time, a surcharge of 8% is applied to banking profits with effect from the same date. In principle, the tax base for this surcharge will be profits as computed for corporation tax but subject to an annual allowance of £25 million but without deduction for group relief, or losses (or other reliefs) arising before 1 January 2016.
The revenue effects of these measures have not been separately identified but they are broadly expected to offset each other, though with a significantly positive income yield in the first two years of implementation.
Restricting tax relief for banks’ compensation payments
Also, in his March 2015 Budget, the Chancellor announced he would prevent banks from using the losses arising from their payment of fines and compensation to reduce the corporation tax they would otherwise have paid. This is implemented with effect from 8 July by the simple strategy of denying a tax deduction for such costs and their associated expenses incurred after that date.
Definition of a banking company
The definition of a banking company has been updated to align the definition used in tax legislation for the bank levy and the bank loss restriction with that used by the PRA and the FCA. The measure is simply a technical change to the wording of the legislation; there is no change in policy.
For further information, please contact us.
Business tax team