B6: Investment scheme related receipts

Disguised investment management fees

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Aimed at schemes converting trading income into capital gains, but applies more broadly

This legislation was brought in to deal with schemes seeking to have investment management income taxed as capital gains. In essence, the fund partnership would pay the fee based on assets under management as a priority profit share to a general partner who was a limited partnership (or LLP\0 and rather than pay all of that onwards as a management fee, the fund executives would be partners in the limited partnership and receive it as profit share from the partnership. The argument was that it retained its character from the fund - usually capital gains. The legislation is, however, much more broadly drafted.

Legislation: ITA s.809EZA - s.809EZH.

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All sums arising directly or indirectly to investment manager taxed as trading income, subject to exceptions

- Disguised fee is any payment that arises to an individual under an arrangement for providing investment management services directly or indirectly to a scheme. Subject to exceptions set out below.

- Applies where the individual has provided investment management services in the past or will do in the future (e.g. retired manager).

- Applies where the individual receives a management fee from an investment scheme that individual does not provide services to if it is part of the arrangement (Draft Guidance, §51)

- Does not apply if the fee is taxed as the individual's employment or trading income. Need not be taxed in the same year (Draft Guidance, §74).

- Investment management services broadly defined (s.809EZE). Includes seeking funds, researching potential investments, acting on behalf of the fund to assist company invested in to raise funds.

- HMRC say it includes any services that support or facilitate investment management services (Draft Guidance, §53).

- Single deemed trade covers all investment schemes for that individual.

- But no trade for any other tax purpose (still an investment business).

- Treated profit of the trade (not receipt), therefore no deductions.

- NICs applicable as normal.

Legislation: s.809EZA.

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Investment scheme

- Includes approved and unapproved investment trust.

- Includes open-ended investment company.

- Does not include most companies (SI 2001/1062)

Legislation: s.809EZA, FSMA 2003, s.235

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Management fee includes loans, money's worth or transaction at undervalue

- Defined to include a loan or advance as well as any money's worth.

- Also includes any transaction at undervalue, to the extent of the undervalue.

Legislation: s.809EZB(1), (3), (4).

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Amounts arising to connected persons (other than company) treated as arising to individual

- If a sum arises to a person connected with the individual, who is not taxed on it as a disguised fee or carried interest, it is treated as arising to the individual.

- Does not apply if the connected person is a company (see below).

- Definition of connected in s.993 used subject to adjustments.

- Not connected simply by being partners in a partnership.

Legislation: s.809EZDA

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Amounts arising to others treated as arising to individual

- If a sum arises to a connected company or unconnected person and the individual has power to enjoy that sum, it is treated as arising to the individual.

- Enjoyment is based on the transfer of assets power to enjoy rules.

- Contractual obligation to pay on amount received may prevent enjoyment condition being satisfied - see Draft Guidance, §239.

Legislation: s.809EZDB.

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Exceptions for amounts arising to connected companies

- Enjoyment conditions treated as not met (such that sum does not arise) if (in essence)

- Only met because of an interest in shares in a company.

- The company is liable to pay corporation tax on its profits, including the sum (or does or would fall within the CFC exemption in TIOPA Part 9A).

- The sum does not arise as part of arrangements with a main purpose of tax avoidance and it is reasonable to assume that but for the arrangements the sum would have arisen to the individual.

- Tax avoidance purpose deemed to be met if sum is applied in investing in a collective investment scheme. 

- Does not require a purpose of avoiding DIMF rules - purpose of avoiding IHT, for example, would suffice (Draft Guidance §233)

- "the legislation seeks to draw a line between genuine corporate management vehicles and more passive structures interposed between a fund manager and their disguised management fee" (Draft Guidance, §200, §221).

- if company forms part of wider remuneration structure which could benefit the individual, exception not met (Draft Guidance, §223)

- "an individual manager or a small management team interposing a corporate entity to receive their carried interest which has not substance willl be caught" (Draft Guidance, §229)

- "Where the structure is a response to tax advice it is likely that the condition will be met" (Draft Guidance, §232)

- List of factors at Draft Guidance §231.

Legislation: s.809EZDB(6) - (9)

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Exception 1: Repayment of investment 

Repayment of an investment by the individual in the scheme is not a disguised fee.

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Exception 2: Arm's length return on investment

- Payment of an arm's length return on an investment by the individual in the scheme is not a disguised fee.

- Investment must be of the same kind as that made by external investors.

- Return must be reasonably comparable to the return made by external investors.

- The terms governing the return must also be reasonably comparable.

- External investor defined in s.809EZE.

Legislation: s.809EZB

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Exception 3: Carried interest other than income based carried interest

- Carried interest is sum that arises by way of profit-related return. 

- Must only arise if there are profits and must vary to a substantial extent based on profits.

- Profits refer to the profits determining returns to external investors. 

- If there was no significant risk the amount would not arise, it is not a carried interest.

- See rules re identifying risk.

- Amounts payable after investors have been substantially repaid with preferred return treated as carried interest.

- Preferred return is broadly a return at least equivalent to 6% compounded annually.

- Profit defined in s.809EZE.

- For income based carried interest see below.

Legislation: s.809EZB, s.809EZC, s.809EZD.

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Deemed to arise from UK trade to the extent that services provided in the UK

- But outside the UK to the extent that services are provided outside the UK.

Legislation: ITA 2007 s.809EZA

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Disregard of tax avoidance arrangements

In determining whether the DIMF code applies, disregard any arrangements with a main purpose of securing that the code does not apply.

Legislation: s.809EZFD.

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Double taxation relief

- Double tax relief is available where a sum charged under the DIMF is also subject to tax on any other basis (whether for the individual or another).

- Double tax relief is also available if the disguised fee is a loan or advance which is paid off by another sum arising under the arrangement and which is taxed.

- Relief must be claimed.

Legislation: s.809EZG.

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Double taxation treaties

- HMRC accept that the business profits article will apply.

- Generally only taxable if permanent establishment exists.

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HMRC manuals: Draft Guidance, §§34, 42 - 45.

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