Summer Budget2015

Wealth & AssetManagementAlert

IntroductionFollowing five years in coalition, today’s Summer Budget was a full-blown effort by the new all-ConservativeGovernment to put their stamp on government taxation and expenditure policy for the next five years. In a wide-ranging speech, Chancellor of the Exchequer George Osborne reduced corporation tax rates, increased personaltax allowances, introduced a national living wage, took steps to rein in non-UK domiciled (non-dom) taxtreatment, introduced benefit cuts, committed to standing by the NATO 2% pledge on defence spending, andannounced measures to cut perceived tax avoidance. Few businesses or individuals will be left unaffected bytoday’s announcements. The only thing conspicuously missing, this being the second Budget of the year, wasthe traditional tweak to duties on cigarettes and alcohol.

Two measures are targeted specifically at carried interest arrangements in the asset management industry. Thefirst of these is intended to take away the tax benefit managers have obtained from the way in which capitalgains are calculated for carried interest purposes, and is likely to have a significant impact on private equity,especially as it comes in with immediate effect. The second is a consultation on new rules aimed at preventingfunds which are not long term investors from adopting private-equity style carried interest structures to benefitfrom capital gains tax treatment.

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Although these changes will be painful for some,one positive that the industry can take from thesenew rules is that they do re-confirm the basicprinciple that carried interest arrangements inlonger term investment funds should be respectedfor tax purposes and will not get re-characterised asfee income.

A number of other measures will be of directrelevance to our clients, including several personaltax changes, and these too are included in thisAlert. Legislation will be published in due course,and consultations on some of the proposals willproceed over the summer. We will release furtheralerts as matters proceed.

Performance linked rewards review

Alongside specific changes included within theBudget to be brought in with summer Finance Bill2015, HMRC has launched a consultation on thetaxation of performance rewards, titled ‘Taxation ofperformance linked rewards paid to assetmanagers’. This consultation continues the recenttrend of focussing on the taxation of theremuneration of investment managers, whichstarted with amendments to the taxation ofmembers of LLPs, including introducing rules forthe management of Alternative Investment FundManagers Directive (AIFMD) deferrals, andcontinued with the consultation on, and draftlegislation covering, the taxation of managementfees.

The purpose of this consultation is to shape newlegislation to be effective from 6 April 2016 that isdesigned to limit the circumstances in whichperformance reward arising to fund managers fromtheir fund management activities may be treated ascapital in nature.

HMRC argues that certain managers havestructured funds that would traditionally have paidperformance fees (subject to income tax) such thatthey now receive a performance allocation from thefunds that they manage and claim capital gainstreatment. In HMRC’s view this treatment isincorrect, but it acknowledges the uncertainty inthe area and so is seeking to implement newlegislation which would bring such performanceallocations into the charge to income tax directlywithout legislating on the wider issue of what istrading activity and what is investing. HMRC notes

that any new legislation would apply only to theinvestment manager and would not impact the fundor its investors.

HMRC notes that it does not anticipate that thosewho would more traditionally be considered part ofthe private equity or venture capital segments ofthe investment management industry should see achange to the taxation of carried interest as a resultof this measure. However, the consultation will stillbe of keen interest to such managers as any futuredraft legislation is likely to include a tax definition of‘venture capital’ businesses or include a definitionof excluded investments in which a venture capitalbusiness would invest. Depending upon the draftingof such definitions, managers who might considerthemselves to fall within such a category might beexcluded.

Equally, this consultation and subsequent legislationcould potentially have greatest impact on managerswho do not sit clearly at either end of the hedgefund or private equity spectrum.

The intended changes following the consultation areseparate from the changes to the taxation of carriedinterest which will be included within summerFinance Bill 2015.

The consultation period in which we will be active isset to run to 30 September 2015. Responses maybe made by way of written correspondencesubmitted by post or email.

Taxation of carried interest: basecost shift

Today’s Budget included proposals that will changethe way carried interest is subject to tax forindividuals who perform investment managementservices for a collective investment scheme throughan arrangement involving one or more partnerships.It is proposed that the new legislation will stipulatethat sums which arise to investment managersunder carried interest arrangements will be chargedto the full rate of capital gains tax, with only limiteddeductions allowed.

The background to this measure concerns theapplication of HMRC’s Statement of Practice D12.D12 is concerned with how capital gains tax ischarged on partners in relation to disposals ofchargeable assets by partnerships. Under current

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law, the application of D12 could result inindividuals who receive carried interest beingcharged to capital gains tax on amounts lower thantheir actual economic returns due to a tax-freetransfer of the investors tax base cost in a fund’sasset to the carried interest-holder (the ‘base costshift’). It is indicated that the new rules, effectivefrom today, will ensure that all amounts received ascarried interest and taxable as chargeable gains willbe subject to limited deductions for considerationactually given by the carried interest-holder with norelief available for base cost shifted from otherinvestors. Credit should be given for employmentincome tax charges, where relevant.

This could significantly increase the effective taxrate applicable to carried interest gains.

Changes to the rules in relation tonon-domicile status

It has been announced that from 6 April 2017,legislation will be introduced to reform the taxationof non-UK domiciled individuals. The proposals areintended to deem a UK tax resident individual to bedomiciled in the UK for tax purposes if they:

► Have been UK tax resident for more than 15 ofthe past 20 tax years; and/or

► Were born in the UK to parents who are UKdomiciled.

The Government intends to consult to seek views onhow to best deliver the reforms, and also in respectof the legislation which is intended to form part ofFinance Bill 2016. It is apparent that the details ofthe reforms and the interaction with the existingrules are yet to be finalised.

Individuals who are UK tax resident but not UKdomiciled (“non doms”) are currently able to claimthe remittance basis of taxation, with the effect thatthey are not subject to UK tax on foreign incomeand gains if they are not remitted to the UK.

The asset management industry is made up of ahighly mobile group of professionals and asignificant number will be impacted by thesechanges.

Long-term UK residents

Non-Dom individuals who have been resident in theUK for more than 15 out of the past 20 tax yearswill be treated as ‘deemed domiciled’ for all UK taxpurposes. This will mean that they will no longer beable to use the remittance basis and their worldwideestate will be in scope of UK inheritance tax (IHT).This reforms pre-existing deemed domicileprovisions which only applied to IHT and deemed anindividual who has been UK resident in 17 out of thepast 20 tax years to be UK domiciled.

Importantly, individuals will remain foreigndomiciled under general law. The domicile of theindividual’s children will be unaffected but will betested independently by reference to the child’s ownindividual circumstances.

UK domicile of origin at birth

Currently some individuals who have a UK domicileat the date of their birth (i.e. a UK domicile oforigin) may emigrate and be able to successfullyshow that under general law they have acquired adomicile of choice overseas as they intend to settlein the foreign country. The stated intention of thesecond reform is to make it impossible for suchindividuals to retain their foreign domicile for UKtax purposes if they later return to the UK.

The Government intends to consult further on theinteraction of the various deemed domicile rules forboth UK domiciles and non-doms and also inrelation to the tax treatment of trusts.

Inheritance tax on UK residentialproperty of non-UK domicilesThe Summer Budget 2015 outlined proposals fornew IHT rules on UK residential property helddirectly or indirectly by (i) non-dom individuals(whether UK resident or non-UK resident) or (ii) byexcluded property trusts (where UK residentialproperty is beneficially owned through foreigncompanies or other opaque structures).

Proposed to take effect from April 2017, thechanges intend to bring all UK residential propertyheld directly or indirectly by non-doms into chargefor IHT purposes, even when the property is ownedthrough an indirect structure such as an offshorecompany or partnership.

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The Government confirmed that it does not intendto change the IHT position for non-doms orexcluded property trusts in relation to UK assetsother than residential property, or for non-UKassets.

Materials released today indicate that a consultationwill be published towards the end of summer 2015,in anticipation of legislation being included inFinance Bill 2017, with changes being effective onor after 6 April 2017.

Corporation tax changesA welcome, albeit unexpected, announcement is theforthcoming change to the corporation tax rate.From 2017 the rate will fall to 19% and from 2020the rate will be 18%. However, the reduction in thecorporation tax rate is unlikely to be extended to UKauthorised investment funds (AIFs), as theapplicable rate of corporation tax for a UK AIF ispegged to the basic rate of income tax (currently20%).

The Government is also introducing changes tocorporation tax payment dates for accountingperiods starting on or after 1 April 2017.Companies with annual taxable profits of £20mn ormore will be required to pay corporation tax inquarterly instalments in the third, sixth, ninth andtwelfth months of their accounting period.Currently, companies with taxable profits of£20mnor more are required to make quarterlyinstalment payments in the seventh, tenth,thirteenth and sixteenth months in respect of anaccounting period. For companies that form part ofa group for corporation tax purposes, the£20mnthreshold will be divided across the numberof companies in the group. Moving from the oldrules to the new rules will therefore require someplanning to ensure a smooth transition.

Dividend tax rate changesFrom 6 April 2016, the Government will abolish thedividend tax credit and replace it with a dividend taxallowance. The new dividend tax allowance willmean that the first £5,000 of dividends earned byan individual should be free of dividend income tax.In addition, the dividend tax rates on dividends overand above £5,000 will be 7.5% for basic ratetaxpayers, 32.5% for higher rate taxpayers and38.1% for additional rate taxpayers. Currently therespective effective dividend tax rates are 0%, 25%

and 30.56% so the impact on investors will dependon personal circumstances.

For investors with significant dividend income thesechanges are likely to represent a tax increase.

Inheritance tax and main residencesAs widely trailed, the Chancellor announcedchanges to support the new IHT relief for familyhomes. An unintended consequence of the rules asoriginally set out was that an individual had tocontinue owning the home until their death in orderto secure the relief. This incentivised the elderly tocontinue owning outsized properties when theywould otherwise have preferred to downsize.

Today’s announcement ensures that the relief willbe available even if the individual has downsized orcompletely sold the property on or after today’sdate. The technical details of how this will beimplemented will be the subject of a consultationlater this year.

Pension contribution changesWith effect from 6 April 2016, the amount availablefor pension tax relief will be restricted forindividuals with incomes (including pensioncontributions) greater than £150,000 or an income(excluding pension contributions) greater than£110,000. The current Annual Allowance of£40,000 may be subject to tapering to a minimumof £10,000 at a rate of £1 reduction for every £2an individual’s income exceeds £150,000. The useof unused Annual Allowance in future years willcontinue to be available but will be subject totapering, if applicable.

In order to facilitate tapering, provisions will beincluded in legislation to align pension input periodswith tax years.

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Income tax thresholdsThe income tax higher rate threshold will increase from its current levelof £42,385 to £43,000 in 2016-2017 and to £43,600 in 2017-2018.The National Insurance contributions Upper Earnings Limit will alsoincrease in line with increases to the income tax threshold.

There are also increases to the tax free personal allowance, from itscurrent level of £10,600 to £11,000 in 2016-2017 and to £11,200 in2017-2018.

Further informationFor further information, please contact one of the following or your usualEY contact:

Robin Aitchison raitchison@uk.ey.com 020 7951 1083

Peter Ames pames@uk.ey.com 0131 777 2262

Fiona Carpenter fcarpenter@uk.ey.com 020 7951 9373

Stuart Chalcraft schalcraft@uk.ey.com 020 7951 1190

Darrin Henderson dhenderson@uk.ey.com 020 7951 2423

Debbie Knowles dknowles@uk.ey.com 020 7951 1995

Russell Morgan rmorgan1@uk.ey.com 020 7951 6906

Mark Semple msemple@uk.ey.com 020 7951 2330

Lynne Sneddon lsneddon@uk.ey.com 0131 777 2339