Legislation was included in the Summer Finance Bill 2015 published on 15 July 2015 to make technical changes to the capital gains tax treatment of carried interest. A summary of the changes was issued by the UK tax authority HMRC on 20 July 2015.

Current situation

Payments to asset managers often consist of a management fee, based on a percentage of the funds managed, and a performance fee related to the performance of the underlying assets during the relevant period.

In some cases the performance fee is given in the form of a participation in the underlying entity which is usually a partnership. The manager therefore gains an interest in the partnership and a right to share in the partnership profits.

If the fund is treated as carrying on investment activity for tax purposes the amounts arising to the manager as a result of the carried interest will be treated as a capital gain for tax purposes. The amounts received are treated as the result of a disposal of chargeable assets, the treatment depending however on the facts and circumstances of each particular case.

Currently the procedure follows the provisions of Statement of Practice D12 on the capital gains treatment of partnerships, setting out the way in which the capital gain is calculated.

New legislation

The new legislation introduced in the Finance Bill 2015 contains technical amendments to the way in which the capital gain is calculated.

HMRC considers that the operation of the rules has in the past resulted in smaller amounts of tax payable than should be the case owing to “base cost shift”. The manager deducts in the capital gains computation a proportion of the base cost of the assets that was provided by third party investors. The individual manager was therefore benefitting in his own capital gains computation from a part of the base cost that was provided by third parties.

Under the new legislation the computation of the capital gain on the investment manager in these circumstances will differ from the treatment in Statement of Practice D12.

If an individual performs investment management services for a collective investment scheme through partnerships the sums received in relation to carried interest will be treated as a chargeable gain subject to capital gains tax. This will apply to the whole amount received by that individual, and only specified amounts will be allowable as deductions in computing the capital gain.

A deduction will be permitted only in respect of consideration actually made by the individual in return for the carried interest (rather than the whole amount that would be allowed by Statement of Practice D12). A credit will be available for employment income tax charges where relevant.

Performance fees paid to investment managers that are charged to income tax will not be affected by these changes.