Two tax experts have warned that changes announced in the Summer Budget could see non-domiciled private equity managers hit with double taxation, something HM Revenue and Customs was swift to deny.
Mark Davies, director of Chartered tax advisers Mark Davies and Associates, said the change to taxation of ‘carried interest’ that fund managers use to reward themselves, has wider implications for non-doms.
He warned the tax changes could see non-dom private equity managers hit with double taxation.
HMRC confirmed the legislation will not affect the capital gains tax treatment of genuine investments in funds made by managers on the same terms as third party investors, nor will it impact the treatment of performance-linked rewards paid to fund managers that are charged tax as trading income.
The rule change will hit where an individual fund manager is given a direct participation in the underlying vehicle, generally a partnership.
However, Mr Davies warned that non-doms engaged in the UK’s private equity industry as investment mangers might participate in a partnership with co-investors in a fund, where the investment managers might get a carried interest or a share in the capital gains in the fund.
“The fund would almost certainly be offshore for tax efficiency for foreign investors,” he added, pointing out that adopting this approach meant non-doms could generate a foreign capital gain if the offshore investment was successful and could opt to pay tax on the whole gain on an arising basis, which the majority chose to do, or chose to pay tax on the remittance basis and pay the remittance basis charge.
Mr Davies said: “It was typical tax planning for non-doms to assign or sell their carried interests to an offshore trust at a time it would be valueless, so personally they would be taxable only when the trust made capital payments and not when each carried interest crystallised; thereby postponing their tax bill, perhaps indefinitely.
“What has changed is that section 103KA TCGA 1992 has been proposed to define a gain on the offshore carried interest as a ‘foreign capital gain’ only if the investment management services are performed wholly outside the UK.
“So, if a private equity non-dom is UK resident when the carried interest pays out, then that proportion of the gain on the foreign asset will be deemed to be a UK source and will be subject to UK capital gains tax as it cannot be sheltered by claiming the remittance basis.
Anti-avoidance provisions will be enacted to apply where arrangements, such as trusts, have been put in place where the avoidance of this tax is one of the purposes of setting up the arrangement,” explained Mr Davies, noting that existing trust structures will need to be “urgently reviewed” to determine whether they are caught and how they might be operated going forwards.
He added that there is also potential for double taxation - something HMRC was swift to deny.
For example, Mr Davies suggested the capital gain on a carried interest held by a family trust offshore and distributed to a UK resident family member could be taxable on that family member and also on private equity non-dom.
This is because there is only relief for double taxation where the private equity non-dom pays tax on the same carried interest twice, for example if there was a carried interest gain assessable on him individually and he subsequently received a distribution from the trust.
Roger Harding, tax director at Gordon Dadds, agreed that on the face of it, it is easy to conclude there is potential to tax the same gain twice - on receipt by the individual and then to the extent capital payments are made to the UK beneficiary - which can be matched with this gain.
“Perhaps this is an unintended consequence, as the legislation is seeking to ensure tax is paid on the true economic gains enjoyed by individuals affected by the new rules.
“Further clarification is needed in this area and this is yet another example of rushed legislation with far reaching consequences that have obviously not been thought through properly.”
However, a HMRC spokesperson said while they could not comment on individual tax arrangements, the legislation includes an express provision to prevent a double tax charge. This allows for relief when the same income or gain would otherwise be taxed more than once.
“We want fund managers to pay UK tax on the full economic gains made on carried interest payments when the funds are managed in the UK.”
emma.hughes@ft.com
