“The government will stop investment fund managers from disguising guaranteed fee income as capital gains,” warned George Osborne, the UK’s Chancellor of the Exchequer, in his Autumn Statement on Wednesday.
Tax experts tell PEI there is very little detail in the speeches accompanying documents to add flesh to the bones of the Chancellor’s statement, but it appears to have in mind partnership structures where annual management fees are linked to the underlying performance of the fund and charged to capital gains rather than income tax – often known as a “management fee waiver”.
A management fee waiver involves effectively giving up fees in exchange for a priority allocation of future profits with the benefit of paying lower taxes on those profits.
“It is anticipated that this could cause issues for some, but not all, UK private equity houses with UK resident GP LP / LLP structures in place, although more detail of the changes will be required to assess the impact,” said Norma Chisholm, tax associate at audit firm Moore Stephens.
Yet, despite the lack of clarity, the UK government announced that it will introduce legislation with effect from 6 April 2015, although draft legislation has been scheduled for publication on December 10.
Responding to the Autumn Statement and its accompanying documentation regarding “disguised fee income”, Tim Hames, Director General of the British Private Equity & Venture Capital Association (BVCA), said: “The structure of the fee arrangements differ across our industry and consequently the tax treatment of the fees can vary. However any management fee income used to pay salaries is subject to income tax. The BVCA will work with the Treasury and HMRC to deal with any concerns they might have about current arrangements.”
The tax practice hit the headlines in the US recently when it was described as “unlawful”, by University of North Carolina law professor Gregg Polsky.
Polsky has urged the US’ tax authority the Internal Revenue Service (IRS) to issue guidance making management fee waivers available only when carry is paid in line of with the net profits of the fund.
“It would require fund managers who wish to turn water into wine to subject their non-risky pay to meaningful entrepreneurial risk. Fund managers will typically be loath to do this and therefore the approach should go a long way towards killing off management fee waivers.”