Michael Beart, Director at Duff & Phelps in London wrote this article for the AIMA Journal.
Many outside of the industry could be forgiven for thinking that asset managers would be in for an easy ride under the first exclusively Conservative Government since 1997. However, with the latest raft of announcements in George Osborne’s Summer Budget following a plethora of changes over the past two years, this couldn’t be further from the truth. CFOs earn their keep by juggling multiple issues at any one time and this article seeks to flag the top five UK tax issues to concentrate on and what action needs to be taken.
Diverted Profits Tax (DPT) – effective from 1 April 2015
Popularly known as the “Google Tax”, the DPT regime is intended to counteract the diversion of profits by multinational groups using arrangements lacking economic substance to exploit tax mismatches or seek to avoid creating a UK permanent establishment. Although initially designed to target large technology and web-based businesses, the scope of DPT goes much wider, imposing an additional 25% charge on diverted profits. Protection under double tax treaties is not available, nor is reliance on OECD compliant transfer pricing policies and documentation. As a result unless 100% of group profits are taxed in the UK, DPT could be applicable.
Operating outside of the standard self-assessment regime, taxpayers potentially subject to DPT are required to make disclosures direct to HMRC within three months of the end of the accounting period. This is likely to catch out many taxpayers who will naturally only contact HMRC when they have a form to complete. Autonomy around calculating DPT liabilities rests with HMRC and DPT must be paid within 30 days of a notice being issued. Payment cannot be postponed on any grounds irrespective of any ongoing review or appeal in respect of the notice.
The original draft legislation excluded partnerships and businesses with UK customer sales less than £10m, however following the consultation period both were removed, dragging more of the industry within scope of the legislation. An SME exemption remains but this is complex and it is important to understand how this applies in a group context.
CFO Action Points: Review the final DPT legislation and apply it to the business taking particular note of operations outside the UK. Determine whether a charge could arise, quantify it and assess whether any exemptions are available. Consider whether any preemptive steps are appropriate. Finally, document the decision whether to make a disclosure or not, making such a disclosure where required to do so. Schedule to review the position annually.
Disguised investment management fee (DIMF) – effective from 6 April 2015
The disguised investment management fee (DIMF) legislation applies where individuals provide investment management services to a collective investment scheme (CIS) through any arrangement involving a partnership. The existence of an LP in the fund structure is sufficient to meet this requirement, although operating via a UK LLP is a more obvious trigger point. The DIMF legislation operates by recharacterising untaxed income (essentially anything not taxed as trading or employment income) arising to an individual as UK trading income subjecting it to income tax and NIC. Exclusions exist for amounts defined as carried interest and co-investments, but any other fees paid from a CIS are potentially caught.
Income recognised outside the UK is one of the targets of this legislation but it extends as far as the receipt of dividends from a UK company, meaning that even the simplest of structures could potentially be within scope. HMRC suggests that dividends will be treated as being received in the capacity of a shareholder only where the company carries on a trade of providing investment management services on a commercial basis and the individual receives arm’s length remuneration. As such, asset managers will be subject to a far stricter tax regime than other industries in the UK who retain flexibility between salaries and dividends in owner managed businesses. Furthermore, caution is urged in attempting to restructure out of the rules as strict anti-avoidance provisions apply.
CFO Action Points: Determine whether any untaxed amounts arise to individuals performing investment management services that would fall to be untaxed. Where dividends are received, determine if that individual receives an arm’s length level of remuneration. Where untaxed amounts exist that are not excluded as carried interest or co-investment then prepare for a DIMF charge.
Taxation of carried interest – effective from 8 July 2015
Admittedly more of an issue for private equity managers, the changes to the taxation of carried interest announced in the Summer Budget demonstrate the Government’s determination to ensure the industry pays its fair share of tax. Brought in with immediate effect, the changes to carried interest overturned long standing practices in the industry by removing base cost shifting and bringing offshore gains within the UK tax net where duties are performed in the UK, the latter point predominantly impacting non-domiciled individuals. In addition, there was the release of a consultation into the taxation of performance linked rewards paid to asset managers. The stated objective of the consultation is to introduce statutory tests to clarify the circumstances in which performance fees may be treated as capital, and provides two possible options to determine this.
Under option 1, certain activities are to be treated as long-term investment activities and would give rise to capital gains treatment. Examples include holding a controlling equity stake in a trading company for at least three years, or real estate for at least five years. However it is option 2 that is likely to be of more interest to the alternatives industry. This is based on the average length of time for which investments are held. This proposal utilises a graduated system that could see part of a portfolio with an average holding of more than six months categorised as capital, meaning part of the performance fee will be subject to lower rate of taxation. Whichever option is adopted there are likely to be fewer winners than losers, but assurances have been made that the changes will not impact the taxation of funds or investors, and the consultation explains that neither the IME nor RFS regime should be impacted.
The consultation closes on 30 September 2015. Draft legislation is expected in December 2015, coming into force from 6 April 2016.
CFO Action Points: Those with carried interest structures should assess the impact of the changes (although this is unlikely to have gone unnoticed by those impacted). All asset managers should follow the consultation closely as certain investment strategies could be affected. Those wishing to make responses on the consultation can do so direct or may wish to liaise with their advisors or AIMA to respond.
Dividend taxation – effective 6 April 2016
The much heralded pre-election promise of a tax lock did not extend to the taxation of dividends as the Chancellor announced an overhaul of the dividend tax regime in the Summer Budget, removing the current 10% tax credit and increasing the rate for additional rate taxpayers. Although a dividend tax allowance of £5,000 per year will be introduced, it will still represent an absolute increase of at least 7.5% for individuals.
For owner managed business the changes to both the dividend tax regime and corporate tax rates will again lead to a reassessment of the most suitable structure. Tax rates alone are only part of the puzzle but a direct comparison of profit extraction routes available to individuals is set out below. Note Class 4 NIC also fell out of the fine detail of the tax lock so the LLP comparative is likely to increase in the future. See table below.
|LLP profit allocation||47.00%||47.00%||47.00%||47.00%|
CFO Action Points: Consider the consequences on shareholders, modelling the potential financial impact. Reassess the suitability of the structure for the business model and long term plans. Consider whether declaring dividends in advance of the rate change is beneficial.
Changes to the non-domicile regime – effective 6 April 2017
Perhaps the most fundamental announcement in the Summer Budget was the removal of permanent non domicile status. An individual who has been resident in the UK for more than 15 out of the last 20 years will be considered from 6 April 2017 to be domiciled in the UK and will no longer be able to access the remittance basis of taxation, i.e. not be taxed on foreign income not remitted to the UK.
A personal issue rather than a business issue some would say, but non-domiciled individuals make up a significant proportion of the UK’s investment management sector, the majority of which are owner managed businesses. It is unlikely that asset managers will move away wholesale but those already with established offices outside the UK may see staff relocating as individual long term plans change, particularly where they have significant personal wealth outside the UK.
CFO Action Points: Assess the impact for the business should senior personnel look to relocate. Consider the impact for the owners of the business, both in term of their ownership but also any co-investments where RFS may now be more relevant. Establish a clear understanding of their long term intentions and plan accordingly.
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