Carried interest - when it arises and how much is the UK gain?
Our previous blog article on the new rules for the taxation of carried interest looked at their general impact on investment managers, including the introduction of the concept of income-based carried interest ("IBCI") and the rule that carried interest that is not IBCI is to be treated as giving rise to UK situs capital gains, irrespective of the situs of the underlying assets, to the extent that it arises after 8 July 2015 and relates to investment management services provided in the UK.
Unfortunately, the relevant legislation is in some respects vague and unclear and HMRC's guidance on how it will interpret that legislation is rather patchy and arguably tendentious.
When carried interest "arises".
This issue is likely to be of significance only where a distribution is made after 8 July 2015 but the transaction or transactions within the underlying partnership(s) that give rise to the distribution occurred before this date. The legislation applies in two sets of circumstances; firstly, where an individual performs investment management services directly or indirectly in respect of an investment scheme under arrangements involving at least one partnership, and carried interest arises to him or her under the arrangements (section 103KA TCGA 1992) or, secondly, when a payment is received in respect of the disposal, variation, loss or cancellation of a right to carried interest (section 103KB ibid).
In the second circumstance, it is unlikely to prove difficult to ascertain when the payment is received. However, when carried interest "arises" in the first of these situations is not defined by the legislation. In its guidance, HMRC has stated that, in its view, the legislation applies “to all carried interest arising on or after 8 July 2015, whenever the arrangements under which it arises were entered into, unless the carried interest arises in connection with the disposal of an asset or assets of a partnership or partnerships which took place before 8 July 2015”. There is usually a delay between the disposal of the assets by the underlying partnership(s) and the distribution of the carry. Accordingly, it should not be assumed necessarily that carry distributions received after 8 July 2015 "arose" on or after that date for tax purposes. This could be of great significance, as if the carry arose before 8 July 2015, it will almost certainly give rise to a foreign gain, which would not be taxable on a remittance basis user if it is not remitted to the UK.
Could post-8 July 2015 gains be partly foreign gains?
The legislation provides that chargeable gains on carried interest arising after 8 July 2015 are foreign gains to the extent that the individual performs the relevant investment management services outside the UK (section 100KC ibid). The law stipulates no specific method of determining whether the investment management services are performed outside the UK, so one would expect that the words of the statute would bear their natural meaning. The one example cited in HMRC's guidance, however, refers to a situation where an investment manager based abroad with carried interest in a specific fund, comes to live and work in the UK, primarily to work on other funds in which he also has a carried interest participation going forward. It suggests, not unreasonably, that in these circumstances the gain on the carried interest from the first fund may well be a foreign gain as it relates to services performed abroad.
However, the narrowness of HMRC's only example concerning foreign carried interest gains is quite striking. Some primarily UK-based investment managers may still spend much of their time outside the UK providing services in relation to funds in which they have carried interest participation. On the face of it, the value of those services should be recognised in determining whether a proportion of the gains arising on carried interest after 8 July 2015 can be treated as foreign gains. Yet as HMRC has offered no immediately relevant guidance in this respect, the position remains unclear. However, care would need to be taken in any event as such an argument might open avenues of enquiry for HMRC into other areas; for example, permanent establishment issues. What does seem fairly certain is that HMRC will scrutinise closely claims that post-8 July 2015 carried interest gains are partly foreign gains, unless the investment manager was based outside the UK for some of the period when his or her services were provided to the fund.
Contact us if you would like to discuss these issues.