UK’s ‘disguised fee’ tax rules unclear

Draft legislation designed to stop investment fund managers from disguising guaranteed fee income as capital gains has created uncertainty for fund managers.

Tax legislation which aims to curb fund managers from giving up fees in exchange for a priority allocation of future profits – with the benefit of paying lower taxes on those profits – has a potentially wider application than expected, say tax experts.

Published on December 10 the draft legislation follows on from George Osborne’s, the UK’s Chancellor of the Exchequer, Autumn Statement where he warned fund managers that the UK government will stop GPs from “disguising guaranteed fee income as capital gains.”

Fund managers’ concerns were initially calmed by the explicit promise from Osborne that individuals’ investment returns and carried interest would not be affected. But, tax lawyers said the new tax rules “over-reach” because they define the terms “carried interest” and “investment return” narrowly and say that everything else is a “management fee”.

Carried interest is defined restrictively as being payments made “out of profits” after investors have received the repayment of their initial investment plus a preferred return, which must be at least 6 percent compounded. Return on investment is then defined, surprisingly according to multiple tax lawyers, as a return reasonably comparable to a commercial rate of interest.

“In labelling some payments to investment managers as ‘disguised fee income’, this is the latest example in a trend on the part of [UK tax authority] HMRC to label many perfectly commercial arrangements as some other type of arrangement ‘in disguise’ in order to collect a greater amount of tax,” said Ben Eaton a UK tax partner at law firm Goodwin Procter. “If this approach continues to become more widespread it will sow further uncertainty into our already over-complex tax regime.”

The new rules are expected to apply from April 6, 2015.