UK GPs await clarity on tax carry changes

The key question posed by the UK government’s statement that it will introduce new legislation regarding the taxation of asset manager performance awards is what constitutes a 'long-term' investment.

The UK government’s statement last week on changes to the way asset managers’ performance awards will be taxed has raised questions as to how long an investment would have to be held to make it eligible for capital gains rather than income tax treatment.

In the government’s first Spending Review and Autumn Statement it said it “will introduce legislation to determine when performance awards received by asset managers will be taxed as income or capital gains. An award will be subject to income tax, unless the underlying fund undertakes long term investment activity.”

The change will be reflected in the upcoming Finance Bill 2016, the first version of which is expected in December. It follows a consultation launched in July to determine the criteria on which to decide how to tax investment fund manager rewards, as previously reported by sister publication Private Equity International.

“The key question is what constitutes ‘long term’,” said Debevoise & Plimpton tax associate Ceinwen Rees. “In its consultation document on this issue, the government indicated that an average holding period of six months will enable carried interest partially to qualify for capital gains tax treatment moving up to full qualification where a fund has an average holding period of two years.”

She added: “Although nothing contrary to this has been published, we are aware the government has informally indicated that a longer period may be required before carried interest begins to qualify for capital gains tax treatment.”

A market source said the government had indicated that an investment would have to be held for three to four years for the manager to qualify for capital gains tax treatment.

The same source said the new legislation was unlikely to apply to private equity and venture capital funds, for which changes to carried interest taxation have already been included in this year’s Finance Act. Instead, it targets managers who trade, such as hedge funds.

“The view is that PE and VC are in one bucket which the Revenue describes as long term investors,” he said.

In the government’s first budget announced in July, it raised the level of capital gains tax on carried interest accrued by fund managers to the full 28 percent rate and eliminated what it referred to as “loopholes”. These included the use of base cost calculations that have been included in existing legislation.

That immediate change to the way carry is taxed was a surprise given the discussions around disguised fee income rules that already took place last year, and concerns raised then about the lack of consultation with the industry, as reported by PEI. Disguised management fee legislation came into effect in April.

This article first appeared in Private Equity International.