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Summer Budget 2015: big tax increases for some fund managers


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Summary: Although the headline rate of capital gains tax is 28%, most carried interest is taxed at a much lower effective rate. That ends today.

In most structures the whole of any carry arising on or after 8 July will be taxed at 28%.

Also announced in today’s Budget were:

• proposals aimed at hedge fund managers seeking capital gains treatment for their performance fee;

• a shake-up of tax on dividends; and

• restrictions to the non-dom regime.

Together all these changes may trigger some significant restructuring by UK based investment managers.

End of the "base cost shift"

Before today carried interest holders were able to take advantage of the acquisition cost of investments (the base cost) even though they themselves only invested nominal capital. That base cost element of the carry was paid out tax free. This produced a much lower effective tax rate because only some of the carry was taxed.

From today the whole carried interest received by a manager will be taxed at 28% regardless of how much represents an actual profit realised from the underlying fund investments. Managers will only be entitled to a tax deduction for sums that they have invested themselves, which in most funds will be a nominal amount.

Co-invest should not be affected but we will need to see the legislation to make sure that geared co-invest is not caught.

No grandfathering

The legislation will be published in the Finance Bill on 15 July but the change will apply to all carried interest arising on or after 8 July. There is no grandfathering.

Funds with UK tax paying investors may operate mechanisms to compensate those investors for the loss of base cost when carry is paid. Such funds should urgently review their arrangements to make sure the managers do not suffer a double whammy of compensating investors for a tax break that has now been lost.

New tax regime for performance linked rewards

The UK tax treatment of returns from investment funds often turns on whether the fund is trading or investing. Hedge and other alternative investment funds are typically treated as trading. That means the performance fees paid to managers of these funds are usually taxed as income.

Some managers have been testing the boundaries of the trading vs investment distinction and arguing that the funds they manage are not trading. That allows them to structure their performance fee in a way that is subject to capital gains tax rather than income tax.

HMRC does not agree that this planning works. However, the trading vs investment distinction is hard to apply in practice so rather than fight these structures in court it wants to change the law.

The government, therefore, plans to introduce a specific tax regime for performance linked rewards paid to individual investment managers. The aim is to provide certainty (albeit certainty of higher taxes) and prevent some managers “unfairly” reducing the tax they pay on performance linked rewards.

The government has published a consultation paper that outlines two possible ways of achieving this:

    • list particular activities which are, in the government’s view, clearly investment activity such that capital gains treatment may be available for performance linked returns; or
    • focus on the length of time for which the underlying investments of the fund are held.

The consultation closes on 30 September. Draft legislation will follow in the autumn with a view to the new rules taking effect from 6 April 2016.


The income tax regime for dividends will be reformed. The archaic dividend tax credit system will be abolished with effect from April 2016 and replaced with a £5,000 annual tax-free allowance for dividends.

Higher rate taxpayers will pay 32.5% on dividends above that amount. For additional rate taxpayers the rate will be 38.1%.

The net result will be a tax increase for individuals who receive significant dividend income.

Non-dom changes

As expected, the Chancellor announced significant new restrictions to limit the availability of non-dom status. From April 2017:

• anybody who has been resident in the UK for more than 15 of the past 20 years will be deemed UK-domiciled for income and capital gains tax purposes; and

• returning non-doms (i.e. those who were UK domiciled at birth but who emigrated and become domiciled elsewhere) will automatically become UK domiciled for tax purposes if they become UK resident again.

The government will consult on the detail of both proposals.

Non-domiciled UK investment managers will need to carefully monitor these proposals and review their domicile status in the run up to April 2017.

Some good news

Finally, and on a more positive note, one of the most eye-catching measures announced was another cut in corporation tax: to 19% in 2017 and then 18% in 2020.

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