UK offers greater carry tax certainty

Following months of worry, the UK government provided private equity managers greater assurance that their carried interest profits would remain subject to capital gains tax treatment so long as the investments were held for at least four years. However, the rules are still in draft form. 

Carry generated from investments held for less than three years will be taxed as income, resulting in performance fees paid to hedge fund managers and other short-term traders taxed at a rate of 45 percent for top earners. Investments held for at least 39 months, but less than 45, will have carry taxed at a blended 50 percent income, 50 percent capitals gain rate, which may prompt managers to hold investments longer.

The proposed new rules will “ensure that a carried interest structure only attracts CGT [capital gains tax] treatment in relation to funds which carry on long-term investment activity,” a policy document said.

The new legislation will be introduced in the Finance Bill 2016 to amend disguised investment management fees legislation introduced in the Finance Act 2015. It follows an industry consultation over the summer and a note in the government’s Autumn Statement that said it was planning to change the way asset manager performance awards are taxed.

Much to the relief of managers, the new rules will not impact co-investments made in the fund by a manager, or an “arm’s length return” on the co-investment. The rules will apply to carried interest paid after April 6, 2016.

Already lawyers are noticing some wrinkles in the draft legislation.

“The average holding period of a fund’s investments is calculated by reference to both the value of its investments and the period over which investments are held, meaning that if a fund exits a high cost investment early, its average holding period could be disproportionally skewed,” Debevoise & Plimpton associate Ceinwen Rees told sister publication Private Equity International.