The new UK carried interest regime takes effect: what should fund managers be considering?

The fund management industry is having to get to grips with an altered UK carried interest landscape with the new taxation regime having come into force on 6 April. The new rules apply to carried interest receipts arising on or after that date. There are no grandfathering provisions for existing carry structures already in place, although limited concessions apply for non-residents carried interest holders who are caught by the new regime.

Under the new regime, carried interest returns are taxed as "deemed trading income", regardless of the underlying character of the return. Consequently, such returns are taxed at combined income tax and National Insurance contributions (NICs) rates of up to 47%. A discount multiplier mechanism may, however, reduce the effective rate for "qualifying" carried interest.

As carried interest will now be taxed as deemed trading income, it will be subject to the "payment on account" rules under which carried interest holders will be required to make advanced payments on account of their expected future tax liability. Consequently, income tax and NICs paid in the previous tax year on carried interest will be relevant to the calculation of any payments on account and could result in distortions year on year as carried interest receipts can be irregular and unpredictable. 

Qualifying carried interest

Where the carried interest is "qualifying" (that is, where it meets the average holding period (AHP) condition), a discount multiplier mechanism will apply. This means that returns will be taxed instead at an effective tax rate for additional rate taxpayers of around 34.1%, including NICs.

The percentage of carried interest that is qualifying depends on the extent to which the fund from which it arises satisfies the AHP condition in relation to its investments and their overall value. Where the weighted average holding period across the fund's investments is 40 months or more, all of the carried interest will be qualifying. Where it is less than 36 months, none will be qualifying, with a sliding scale between 36 and 40 months.

The general structure of the new legislation covering the AHP condition broadly replicates the previous income-based carried interest (IBCI) rules (now repealed), with which advisers and fund managers are familiar and to which the fund management industry as a whole has prior exposure. 

However, in a significant departure from and extension to the IBCI rules, the AHP condition in the new rules applies to all carried interest holders – both employees and non-employees, such as LLP members. As a result, a greater range of funds and fund managers will need to consider the AHP condition now and in the future.

The burden of complying with and monitoring the AHP condition, together with other areas of compliance under the new regime, will be significant across the fund management industry and should not be underestimated. Fund managers will need to track investment dates, values and holding periods across all fund assets on an ongoing basis in order to determine whether any of the carried interest from the funds in question is "qualifying".

Territorial scope 

The new regime also significantly expands the UK's territorial reach in relation to non-resident carried interest holders. Non-UK residents will be subject to income tax on carried interest to the extent that it relates to investment management services performed in the UK, subject to the terms of any applicable double tax agreement (DTA). 

The basis of the potential charge will be the number of "UK workdays" – days on which more than three hours of investment management services are performed in the UK in respect of any fund. In recognition of the potential complexities and uncertainties arising from other jurisdictions' approaches to the application of DTAs, certain limitations have been included in the new rules in relation to qualifying carried interest. However, regardless of any such limitations, the new rules mean that fund managers will need to consider their potential application to non-UK resident carried interest holders as well as UK resident holders.

Osborne Clarke comment

HMRC has yet to publish guidance on the new rules for the fund management industry. However, now that the regime has come into force, there are a range of actions that fund managers can consider in light of the new legislation.

• Consider the new rules when setting up new fund and carried interest structures to ensure they work optimally within the new rules.
• Review existing fund and carried interest structures proactively to determine how they may be impacted by the new rules; for example, some bespoke carried interest structures may not fall squarely into the new rules and tailored advice may be required.
• Implement appropriate structures and procedures to be able to monitor the AHP condition across existing and future funds where applicable.
• Ensure structures and procedures are in place to track any UK workdays of non-UK resident carried interest recipients.

If you would like to discuss any aspect of the new legislation, please speak to one of the contacts below.