UK: Hedge funds hit back at carried interest claim

Industry body says hedge funds in Britain almost never use the carry system targeted by George Osborne in last week’s Budget, The Telegraph reports

Hedge funds have claimed they were unfairly singled out in a Budget crackdown on the “carried interest” tax loophole, arguing that almost no British funds are set up in this way.

The Chancellor said on Wednesday that fund managers will face a much tougher test if they want to claim their share of profits are a carried interest in their fund rather than performance-related pay, enabling them to pay capital gains tax at up to 28 per cent rather than income tax at up to 45 per cent.

Despite the Budget documents predicting a £1.8bn public windfall from “private equity and hedge funds”, the hedge fund trade body said the UK firms run investment strategies based almost exclusively on trading, rather than holding assets for long periods to generate capital gains.

“We were disappointed to see hedge funds referenced in the Budget documents in relation to carried interest. Active hedge fund strategies produce trading profits which managers receive as fees that are taxed as income at standard income tax rates – as we have said before – and not as capital gains,” said Jack Inglis, chief executive of the Alternative Investment Management Association.

Investment managers are typically paid in two ways: a flat fee for running the fund, plus a share of the profits if it performs well. This profit-share can be structured to pay tax as if the managers were investors in the fund, with a “carried interest” in capital gains from a successful asset sale, even when they have personally invested little.

“The government believes that investment managers should not automatically be able to access capital gains tax treatment on the performance linked reward they receive from the fund. The ability for investment managers to obtain this treatment should be dependent upon their fund’s activities clearly being of an investing nature,” the Government said in a consultation paper.

Fund managers who want to take advantage of the capital gains system will have to prove they are genuine co-investors, with a test that could include a requirement to invest for at least three years, or five years for property, as well as adherence to other conditions, subject to a consultation with the industry.

HMRC said the Government holds a “long standing assumption that the activities of many alternative funds amount to a trade for tax purposes”.

Alex Henderson, tax partner at PwC, said the changes “bring to an end a basis of taxation agreed with HMRC as long ago as 1987 when the industry was in its infancy. This is one of a series of changes that have affected the way the industry has been taxed in recent Budgets and reflects the Chancellor’s progressive tightening of the tax regime and withdrawal of reliefs.”

Since April, fund managers have no longer been able to disguise their management fees in order to avoid income tax, generating an expected £160m in tax in 2016-17.