Consultation on the taxation of carried interest

Additionally, in the consultation, the government stated that it is their opinion that “the current tax regime does not appropriately reflect the economic characteristics of carried interest and the level of risk assumed by fund managers in receipt of it”. They note that “carried interest is a form of performance-related reward received by fund managers, primarily within the private equity sector” and that other sectors are taxed differently. They go further to confirm that, as a result, they “will be taking decisive action”. However, it should be noted that the government has stated their intention “to protect the UK’s position as a world-leading asset management hub”, recognising the sector’s vital importance to the UK economy.

The government was particularly interested in gathering evidence on:

1. How can the tax treatment of carried interest most appropriately reflect its economic characteristics?
   • The government notes that there are a range of circumstances in which carried interest is received, and that the characteristics of the reward will not be the same in all cases.
2. What are the different structures and market practices with respect to carried interest?
   • The government is particularly interested to understand how these differences should be taken into account as part of its reforms.
3. Are there lessons that can be learned from approaches taken in other countries?
   • While many other countries have specific regimes for the taxation of carried interest, their detail and conditions for access vary.

Our thoughts

Firstly, we consider reference to a “carried interest loophole” to be incorrect. Rather, it is arguably decades’ worth of regulatory and fiscal policy by successive governments that has built one of the most efficient and world-leading asset management and carried interest regimes globally. Indeed, there have already been significant amendments to the UK tax framework to close down previously common planning arrangements to ensure the tax treatment better reflects true economic risks and returns to managers.

It should be noted that the default UK tax position for carried interest is that carry arising is subject to income tax rates of up to 45%. There are exceptions that switch carried interest participants to (very broadly) a minimum main special capital gains tax rate of 28% applying. But carry arising is then taxed depending on the nature of the underlying return in respect of which carry arises. So actually for those amounts of carry arising from underlying dividend or interest returns would still be subject to higher rates of income tax.

It is interesting that the government states its intention to protect the UK’s position as a world-leading asset management hub, but seemingly contradicts itself in wanting to “take decisive action” on this tax framework. There is a real risk that any material and “decisive” change to the regime would actually build uncertainty into the tax framework, arguably undermining the UK’s position as a world-leading asset management hub. It is also important to consider this against the post-Brexit landscape, where investment into the UK is more important than ever.

Additionally, many private capital businesses already based here have a highly mobile and flexible workforce, meaning that these businesses could be encouraged to relocate overseas to take advantage of more attractive tax jurisdictions. 

As noted above, from both a regulatory and tax perspective, the UK already has one of the most effective carried interest regimes available. We hope that the government builds on the current regime and takes seriously its role in protecting the UK’s position as a world-leading asset management hub, rather than creating uncertainty by making wholesale changes or introducing an entirely new regime.

For existing fund managers operating carry, it is a great opportunity to reflect on how your funds and carried interest are structured and consider the potentially wide-ranging impact of any changes.

And for those of you who are considering setting up a new venture fund, structuring your fund and performance related rewards will be more challenging in a landscape that may be changing.

We eagerly await the detail to the conclusion of the consultation that should be set out in the Budget on 30th October and would be delighted to discuss the above consultation or the outcome of the Budget as they pertain to your own circumstances. 

Should you wish to discuss, please fill out the form below and one of our experts will be in touch to discuss how we can help.