UK budget leaves carry alone

Private equity tax planners were on high alert when George Osborne delivered his budget on Wednesday.

In his last major budget announcement late last year, the UK Chancellor of the Exchequer said he would stop GPs “from disguising guaranteed fee income as capital gains,” leading private fund professionals to worry the initiative would catch carried interest payments.

The budget, however, reaffirmed “sums linked to performance, often described as ‘carried interest,’ nor returns which are exclusively from investments by partners” would not be part of new legislation taking effect next month that will “ensure that sums which arise to investment fund managers for their services are charged to income tax,” the budget said.

More details are expected in the Finance Bill to be published next week, but industry tax experts hint the legislation appears to have in mind partnership structures where annual management fees are linked to the underlying performance of the fund and charged to capital gains rather than income tax – often known as a “management fee waiver.”

A management fee waiver involves effectively giving up fees in exchange for a priority allocation of future profits with the benefit of paying lower taxes on those profits.

“It is anticipated that this could cause issues for some, but not all, UK private equity houses with UK resident GP LP/LLP structures in place, although more detail of the changes will be required to assess the impact,” said in a recent exchange with pfm, Norma Chisholm, tax associate at audit firm Moore Stephens.

Responding to the Autumn Statement and its accompanying documentation regarding “disguised fee income,” Tim Hames, director general of the British Private Equity & Venture Capital Association (BVCA), said at the time: “The structure of the fee arrangements differ across our industry and consequently the tax treatment of the fees can vary. However any management fee income used to pay salaries is subject to income tax. The BVCA will work with the Treasury and HMRC to deal with any concerns they might have about current arrangements.”

Tax lawyers predict much of the lobbying campaign to center around explaining to HMRC the peculiar tax impact on carried interest and co-investments from the legislation. But failing that, the HMRC will be lobbied to write additional guidance clarifying the matter.