In this edition of the Andersen Tax newsletter, we take a detailed look at the Disguised Investment Management Fee and the associated carried interest rules. These were introduced back in 2015, and perhaps their full force hasn’t been felt as yet, as it takes a period of time for tax returns to be filed, and for HMRC to raise enquiries. That said, the asset management industry was rocked when the rules were introduced because, up until that time, it was possible to structure carry in a very tax efficient manner e.g. by virtue of the base cost shift rules and the remittance basis for non-domiciled individuals. Fund managers used to having carry taxed at effective rates as low as 0% were, overnight, dragged kicking and screaming into the real world, faced with rates of up to 47%. It’s fair to say that a lot of the structures we have seen reached byzantine proportions of complexity in their quest to achieve a very low effective tax rate, and it’s not difficult to see from a policy perspective why the Government sought to redress the balance, although many would question whether they went a step too far – we are aware of a number of fund managers who left after the rules were introduced.
Despite various changes to the UK’s non-dom regime over the past decade, it remains very attractive to HNWI’s, not least London, which is the best city in the world! Claims that tax competition is a bad thing haven’t stopped many countries following the UK’s lead. Portugal, Malta, Italy and Spain are all relative newcomers whilst Switzerland, Monaco, the Channel Islands and Isle of Man are well established targets for restless HNWIs. The UK remains attractive for one critical reason: it is actually possible to live and work here (without going insane). Whilst the other jurisdictions have more sun, warmer sea and the added benefit of snowy peaks (Italy, Spain and Switzerland), the UK offers a broader package of lifestyle and tax benefits. With this in mind, we take a look at the benefits of the UK’s remittance basis from a US perspective. We also take a look at the benefits of Spain’s inpatriate regime otherwise known as the “Beckham Ruling”, as well as the potential pitfalls to watch out for.
Finally, our focus turns to ORIP – Offshore Receipts in Respect of Intangible Profits. Like DIMF these are a relatively new set of rules introduced by HMRC to counter the avoidance of tax by multinationals seeking to sweat IP via tax haven entities.
We hope you enjoy this edition of the Andersen Tax newsletter. Any comments and feedback are welcome as usual.
Happy reading and stay safe!
The Andersen Tax Team
The UK | Refresher on UK taxation of Fund Managers
In recent years, HMRC have become concerned that some individuals working for asset management businesses were not paying sufficient (or in some cases any) taxes on their remuneration, namely investment management fees, carried interest and performance fees.
The government, therefore, introduced rules which were designed to ensure these individuals paid an appropriate amount of tax on their earnings. These were introduced in stages, the first of which took effect on 6 April 2015.
The rules are extremely difficult to navigate. HMRC seem to be of the view that there is a high risk of non-compliance amongst fund managers, due to the complexity of the rules and, in some cases, individuals not being aware of them. We are increasingly seeing HMRC audits, and in some cases HMRC are trying to use their powers of ‘discovery’ to assess tax for years for which the usual statute of limitations has closed. From experience, HMRC are focused on whether the correct amount has been reported on the individual’s return, taking account of the detailed operation of the legislation, discussed below.
As such, we thought this would be an appropriate point in time to provide a refresher on the rules.
When an individual performs investment management services for a fund, it is necessary to consider the application of the rules. There are two sets of rules to consider, the ‘disguised investment management fee’ (‘DIMF’) rules and the carried interest rules.
A DIMF charge arises when:
- an individual performs investment management services in respect of an investment scheme under any arrangements; and
- a ‘sum’ (i.e. ‘money’s worth’) arises from the scheme to (i) the individual, (ii) to someone else connected to the individual other than a company (e.g. spouse, close family member or family trust) or (iii) to an unconnected person or a connected company and one of the ‘enjoyment’ conditions is met. The ‘enjoyment’ conditions are very widely drafted and give rise to interpretation difficulties. However, very broadly, they are intended to kick in if the sum may benefit the individual or a connected person, either now or at any time in the future.
A sum arising to an individual that is considered DIMF income is subject to 45% income tax and 2% NIC.
There are, however, certain cases where a sum is received for investment management services and it is not considered DIMF. These exceptions apply when the sum received is:
- A capital repayment of co-investment made by the individual in the scheme. The sum arising must be in relation to an investment that has the same terms as an investment made by an external investor in the same fund.
- An arm’s length return on co-investment that the individual has made in the scheme. Again, the sum arising must be in relation to an investment that has the same terms as an investment made by an external investor in the same fund.
- Carried interest, in which case it is taxed under the carried interest rules (explained below).
- An amount for which the fund manager has paid market value.
- Already taxed as employment income or trading profits of the individual.
- The sum arises to an unconnected person or connected company (see above), but meets one of two very narrowly defined exemptions, being:
- that the sum arises to either a UK company and is subject to UK corporation tax or to a non-UK company and is subject to foreign tax at a rate of at least 75% of the UK corporation tax rate; or
- the sum arises to a company in which the individual personally owns shares.
The two exemptions above do not, however, apply if the structure has a main purpose of avoiding income tax, capital gains tax, corporation tax or inheritance tax.
The carried interest charge applies (instead of DIMF) when the sum arising to an investment manager is considered DIMF, but the carried interest exemption applies. The sum arising must meet the definition of carried interest to qualify, namely:
- the structure must be of a standard private equity European waterfall model, whereby investors receive a 6% preferred return and return of capital before carry becomes payable; or
- there was a significant risk when the carried interest was granted to the individual that no sums would subsequently arise to the individual.
If the carried interest exemption applies, then the following rules apply:
- The sum arising is still considered as DIMF (and taxed at 47%) if the sum arising meets the definition of Income Based Carried Interest (‘IBCI’). The sum is IBCI, broadly, if the investments giving rise to the payment have a weighted average holding period of less than 40 months, subject to various exceptions (NB – the IBCI rules apply only to sums arising from 6th April 2016).
- Otherwise, the carried interest is taxed at 28% (capital gains rates), unless the actual profit is income in nature, in which case it is taxed at income rates.
- Where capital gains rates apply, non-domiciled individuals who file on the remittance basis are eligible to treat a portion of their carry as ‘foreign’ and are therefore taxed only if it is remitted to the UK. There is no fixed rule for calculating the portion of UK taxable carried interest. The most common method is to apportion the carry based on workdays over the life of the fund, or from the date the individual started working for the fund. Appropriate bank account segregation is required if the individual wishes to be able to remit the UK portion of the carry to the UK without being deemed to have remitted the offshore portion.
- The opportunity to claim overseas workday relief is very limited if the carried interest is considered ‘IBCI’. This is only available for individuals who were non-UK resident for at least 5 years before their arrival in the UK. The relief is only available for the first 5 years of UK residence in relation to pre-arrival services only.
The DIMF and carried interest rules are extremely complex. However, our team in London have extensive knowledge and practical experience in dealing with HMRC on the matter.
Please contact Julian Nelberg on +44 7803 502 555 or julian.nelberg@AndersenTax.co.uk
The UK | Moving to the UK & Pre-arrival Planning
Individuals moving to the UK should have a basic understanding of the UK tax system before they move and should also consider pre-arrival planning to optimise their tax and avoid adverse consequences. The issues are especially important for Americans, who remain subject to US taxes and are therefore at risk of double taxation.
Domicile and Residency
Prior to arriving in the UK, an individual will need to know if they are ‘non-UK domiciled’ or ‘UK domiciled’.
If they are non-domiciled, will they remain non-domiciled once they are in the UK?
An individual could become immediately domiciled in the UK if they are moving here permanently (or retiring here). Also, if an individual was born in the UK but emigrated overseas, upon returning to the UK they may be considered ‘UK deemed domiciled’.
Arising vs Remittance basis
If an individual is non-domiciled, they have the choice between filing on the arising or remittance basis of taxation.
An individual claiming the remittance basis is generally taxed only on their UK sourced income and gains and any foreign income earned whilst UK resident, which is remitted to the UK.
The remittance basis allows individuals to keep their UK affairs simple. However, a charge of £30,000 is due if the remittance basis is claimed and the individual has been UK resident for 7 of the past 9 tax years. This charge rises to £60,000 after being resident for 12 out of 14 tax years.
Once a non-domiciled individual has been resident in the UK for 15 out of 20 years, they become deemed domiciled, at which point they can only file on the arising basis.
Under the arising basis, individuals are taxed on their worldwide income and gains. Individuals coming to the UK who are UK domiciled or deemed domiciled, can only file on the arising basis.
Non-UK Investments and Positions
Before arriving in the UK, individuals may need to resign from non-UK trustee and directorship positions to prevent the entities being brought into the UK tax net.
If the individual is UK domiciled or deemed domiciled, their overseas investments should be reviewed to ensure there is no mismatch between the UK and foreign taxation of the investments, since this could result in double taxation.
Whilst the ‘remittance basis’ can be highly beneficial, individuals need to be aware of the rules, which are complicated and, to some extent, seemingly designed to trigger tax in unexpected ways.
Individuals may benefit from establishing a ‘clean capital’ account prior to arrival. This allows remittance basis filers to access foreign funds accumulated prior to becoming UK resident, without being subject to UK taxation upon remitting.
Specific issues for Americans
American citizens and green card holders face additional difficulties, for example:
- Mismatch between UK and US treatment of investments e.g. US LLCs, US tax-exempt interest, Incentive Stock Options, trust income/distributions and most US mutual funds.
- Certain issues can be avoided by claiming the remittance basis, whilst available.
- Long-term residents (> 15 years) can face economic double taxation unless they undertake restructuring.
- Estate planning: Potential UK Inheritance Tax exposure if the individual dies holding UK assets or is domiciled in the UK at the time of death.
- UK tax reporting: Ensure records are kept should HMRC ever challenge an individual’s tax filings, e.g. bank statements, flight documentation, copies of advice.
- Non-tax issues: Immigration, obtaining a visa, schooling, insurance of high value assets, real estate searches, staff administration and record keeping.
If you would like more information,
please contact Julian Nelberg on +44 7803 502 555 or julian.nelberg@AndersenTax.co.uk
or Paul Lloyds on +44 7518 810 993
or Luke Jenkinson on +44(0) 7494 157 948
Spain | Considerations for those thinking of Relocating
Spain continues to be an attractive destination for high net worth individuals and, like the UK, Italy, Malta, Portugal and various other countries, it does have a specific tax regime targeted at attracting ‘inpatriates’. Royal Decree 687/2005, otherwise known as the “Beckham Ruling”, was a law passed in 2005 aimed at attracting skilled individuals to live in Spain. It gained its name after footballer, David Beckham, became one of the first foreigners to take advantage of it.
Prior to the introduction of this rule, any foreign workers remaining in Spain over 182 days in a tax year would become Spanish tax resident and subject to Spanish tax on their worldwide income and gains (subject to the applicability of a relevant DTA). Since the introduction of the Beckham Ruling, foreign workers employed by a Spanish company, or a Spanish branch of a foreign company, can apply for a ruling to be treated as if they were non-Spanish tax resident.
The effect of this is that the individual is only subject to:
- income tax at a flat rate of 24% on the first €600,000 of income earned in Spain;
- income tax at 45% on any Spanish income in excess of €600,000
- income tax at 35% on gains realised on the sale of Spanish situs assets (e.g. Spanish real estate); and
- net wealth tax on Spanish situs assets only.
The ruling is available to all foreign workers, although it is geared more toward wealthier expats (i.e. middle and upper management, those with specialist skills etc.). In order to benefit, however, a specific ruling application must be made. If the ruling is granted, it applies in the year of arrival and for the following 5 tax years (i.e. for a total of 6 years), during which time foreign income, gains and assets are not subject to Spanish taxation.
The regime is open to individuals who have:
- not been resident in Spain for the previous 10 years;
- apply within 6 months of registering with the Spanish Social Security system; and
- are employed in Spain.
What’s not to like?
Provided the individual can show that they are genuinely employed by a company that they do not have more than a 25% interest in, rulings are granted relatively quickly (in our experience within 30 days). The benefits are significant in respect of non-Spanish source income/gains and are time limited. If the individual intends on staying in Spain past 6 years, planning will need to be undertaken to take account of the following:
Trusts: The concept of a trust is not recognised by Spanish law and there is a presumption of tax fraud / evasion when one is unearthed by the authorities.
Modelo 720: all residents of Spain must make an annual declaration of all non-Spanish assets valued at more than €50,000 (property, bank accounts and investments). Non-disclosure results in significant penalties.
Inheritance Tax: Spain doesn’t have a blanket spouse exemption for inheritance tax purposes. However, individuals that have been resident in Spain for at least 3 years receive an exemption of 95% of inheritance tax when their principal residence or family business (in Spain) is left to a spouse, parent or child who has been living with them for at least two years before their death. Here’s the sting: the principal residence must be valued at less than €122,606 (there is no limit for a business) or the inheritance per heir must be less than €122,606, above which normal inheritance tax rates apply.
Wealth Tax: Spain re-introduced wealth tax in 2011. It is imposed on worldwide net wealth with each taxpayer entitled to a standard allowance of €700,000. The 17 autonomous regions are able to set their own tax rates and allowances within certain limits. If a region does not set such rates, the standard progressive rates range from 0.2% (on the first €167,129.45) to 2.5% (on the excess over €10,695,996.06).
There are limited exemptions for shares in unquoted companies in which the taxpayer holds:
- more than 5% of the capital; and
- a managerial function which is the source of more than 50% of his total income.
If you are interested in relocating to Spain generally or under the Beckham Ruling please contact Miles Dean on +44 7785 770 431 or miles.dean@AndersenTax.co.uk
The UK | ORIP – bark worse than bite?
Since the OECD began its project to stop base erosion and profit shifting in 2013, the UK Government has introduced a number of measures to protect the UK’s tax base, including the Diverted Profits Tax, Corporate Interest Restriction and now the Offshore Receipts in Respect of Intangible Profits (or ORIP for short) rules.
Originally, the Government contented itself with beefing up the UK’s rules on withholding tax on royalties. However, it was then decided they had not gone far enough and widened the net to anyone who exploited intangible property (not just intellectual property) in order to generate UK sales, wherever they are based and no matter how many levels there are between the UK customer and the holder of the intangible property. The new rules also apply whether the exploitation led to an income receipt or a capital one. The rules are wide ranging and as the charge is to income tax, the rate is 20%. Further, as this is a withholding tax, it is on gross payments not profits.
The aim of the rules is to target multinationals that park their intangible property in low or no tax jurisdictions. The rules are extra-territorial because they only apply to companies that indirectly receive money from a UK customer.
Example – Gadget Plc
Gadget Plc, resident in Utopia, a country that has no corporation tax, owns the IP to the “wonder gadget”. Its subsidiary, Gadget Sales Ltd resident in Ruritania, a “normal tax rate” country, has a license to manufacture the “wonder gadget” which is sold to customers in the UK via local sales subsidiaries. Gadget Sales Ltd makes payments of £20mn to Gadget Plc in respect of those UK sales.
Gadget Plc has no direct sales or contacts with the UK, but the payments it is receiving are derived from UK sales and therefore within the rules. Gadget Plc will be chargeable to UK income tax at 20% upon those sales.
The rules do have an exemption for any recipient who is resident in a country with which the UK has a “full tax treaty”. For example, if Gadget Plc was resident in Ireland, the rules would not apply.
The definition of “full tax treaty” is one that contains a non-discrimination article that applies to “nationals”. You would think this would apply to all of the UK’s modern treaties, but no, there are some notable exceptions to this exemption. These include Hong Kong, Jersey, Guernsey and the Isle of Man, all of which have modern treaties that contain non-discrimination articles but do not refer to nationals as they do not have their own nationals. For example, “nationals” of Jersey and “nationals” of the UK are, in fact, both British Nationals. Therefore, the non-discrimination article in the Jersey/UK tax treaty cannot use the term “national” as no-one would know whether you were referring to Jersey or the UK.
However, all is not lost if the payment ends up in a company resident in one of these territories. This is because although the “full treaty” exemption within the ORIP rules does not apply, the normal treaty rules do. Therefore, the tax treaty will, as usual, take precedence over domestic legislation, including the ORIP rules. Using our example, if Utopia has a tax treaty based upon the Jersey tax treaty, the UK will only be able to tax Gadget Plc if either it has a taxable presence, known as a permanent establishment, in the UK, or it is receiving royalties from someone in the UK. As neither of these apply, it has no presence in the UK and the payments it receives are from a Ruritanian company, the UK cannot tax the payments it receives.
It is worth noting that companies resident in a full DTA territory will remain within ORIP if they are subject to tax there only on local source income or on a remittance basis.
It does seem therefore that for once, the bark is worse than the bite.
If you have any queries regarding the ORIP rules or the UK’s double taxation treaty network, please contact, please contact Zoe Wyatt on +44 7909 786 144 or zoe.wyatt@AndersenTax.co.uk
or Andrew Parkes on +44 7522 229 589 or andrew.parkes@AndersenTax.co.uk