This year’s Autumn Statement delivered by the Chancellor of the Exchequer in Parliament on 5 December 2013, and the subsequent draft Finance Bill and H.M. Revenue & Customs (HMRC) and H.M. Treasury press releases of 10 December 2013, brought a mixture of good and bad news for the financial services industry.
The Good News
Aside from welcome abolitions of Stamp Duty Reserve Tax (SDRT) on dealings in interests in UK-domiciled exchange-traded funds and in relation to the Schedule 19 Finance Act 1999 SDRT charge on fund redemptions, both effective from April 2014, the UK also had new draft legislation extending the scope of Section 363A Taxation (International and Other Provisions) Act 2010. This latter change is highly significant, in that it purports to ensure that an alternative investment fund (AIF), managed by an alternative investment fund manager (AIFM), could not be UK tax resident for UK tax purposes. This measure is designed to encourage the management of AIFs by AIFMs established in the UK.
Could the introduction of this new legislation mean the end of the trips abroad for UK directors in order to hold board meetings outside the UK and/or the need to appoint off-shore AIF directors? Our view is that, unfortunately, the legislative revisions will not enable such wide-sweeping changes to procedure, because it is a condition of the relief that the AIF maintain its residence in its own jurisdiction of incorporation. That said, and subject to local law requirements as to residency, it should be possible to hold the occasional board meeting in the UK or to enable directors to occasionally phone in to meetings from the UK, and also possibly to increase the UK representation on the board of directors of the AIF if desirable from a commercial perspective. Further, care should be observed in ensuring that any changes to established procedure do not go so far as to bring into question the place where the AIF belongs for VAT purposes (which should continue to remain outside the UK).
There is also some confusion (unintentional, we believe) as to the status of Cayman AIFs under this proposed new legislation, as the new provisions have a requirement that the AIF be resident in its own jurisdiction for the purposes of any income tax in its jurisdiction. Hopefully, this point can be clarified in due course, as our understanding is that it was not the intention of HMRC to exclude Cayman AIFs from the benefit of this legislation.
The Bad News
The Partnership Changes
Certain of the changes in relation to LLPs with corporate members were addressed in the DechertOnPoint, Pre-Budget Review: Changes to the Taxation of Mixed Partnerships in the UK. Suffice to say, these new anti-avoidance provisions have gone further than expected and have also included provisions to circumvent some of the initial planning ideas that we had been considering.
The proposed legislation, among other things, will force LLPs with corporate members to consider whether the profits they attribute to such corporate members are in excess of an amount to be calculated in accordance with the legislation. This amount is to be calculated by reference to transfer pricing concepts in terms of what is an appropriate return for any services rendered by the corporate members to the LLP, together with a deemed reasonable rate of return on any capital contributed to the LLP by the corporate members. This latter point poses some very interesting questions as to what is a reasonable rate of return for these purposes and, indeed, whether any arm’s length third party would even have lent any money to certain fund managers. If excess profits are determined to have arisen to the corporate members, it is then necessary to consider whether it is “reasonable to suppose” that these excess profits are properly attributable to an individual member who has “power to enjoy” such excess corporate profit. HMRC has issued some helpful guidance, but it is clear that many situations are not adequately covered and therefore will require further clarification.
The “disguised employment” provisions are not quite what advisers had been expecting following the consultation process. Paraphrasing, a member will be treated as an employee for income tax purposes if:
It is reasonable to expect that 80% or more of the member’s pay is either fixed or, if variable, is not variable by reference to the overall profits of the LLP’s business or, in practice, is not affected by the overall amount of the firm’s profits [our emphasis]; and
The rights and duties of the member do not give the member significant influence over the affairs of the LLP; and
The member’s contribution to the capital of the LLP is less than 25% of the disguised salary payment in the relevant year.
Since all three conditions must apply for a member to be treated as an employee, the member only has to tick the box on any one of the above to be treated as self-employed.
The related guidance confirms that receiving a share of profits by reference to only a part of the business or to personal performance-related calculations will not generally count as variable pay, as it is necessary to have pay that is variable based on the profits of the business as a whole.
The “significant influence test” was not included in the original proposals and it is unclear how far this test will extend. The guidance provides comfort only for those on the governing body of the LLP, although it should also cover those with significant and meaningful voting rights.
In short, unless the draft legislation changes following consultation, it might be necessary to change the variable aspect of pay and/or require some members to make significantly increased capital contributions, if self-employment status for tax purposes is to be preserved in certain cases. The new rules (once final) will apply with effect from 6 April 2014.
As expected, the new tax provisions that permit the deferred remuneration and payment-in-kind arrangements to operate on a “net of tax” basis extend to AIFMs whether or not they are required to implement deferral, etc., and can apply to both deferred profits in cash and remuneration in the form of instruments that must be retained for a period of at least six months. However, the rules appear to apply only where deferral and payment-in-kind arrangements are consistent with the ESMA guidelines. To quote HMRC, “In order to be accepted as consistent with the guidelines, the arrangements must incorporate all the relevant provisions of the guidelines as they would do if the guidelines were applicable to the individual concerned” (paragraph 4.10 of HMRC’s Technical Note of 10 December 2013). This appears to suggest that a firm can only take advantage of the rules if it defers between 40% and 60% of variable remuneration and/or pays 50% of variable remuneration in non-cash instruments of the funds retained for a minimum six months. HMRC may therefore not allow a firm to rely on these tax provisions if the firm chooses to implement a lower level of deferral or payment in instruments, or a shorter period of retention. This is something that we are trying to clarify.
We expect to receive greater clarification from HMRC on a number of aspects of these rules in the coming months.