Introduction
On 15 March 2023, the UK government revealed the widely anticipated Spring Budget, which contained a number of measures that may be of interest to asset managers.
Carried Interest – election to be taxed on an accruals basis
US citizens realising carry while tax resident in the United Kingdom may currently face punitive rates of tax, due to double taxation caused by mismatches in the timing of income inclusions under the US and UK tax systems. In brief, private fund agreements often cause the United States to tax carry returns on a hypothetical asset liquidation basis, giving rise to taxable income before there is any corresponding cash entitlement. The UK, on the other hand, generally taxes carry on an arising basis in accordance with the cash distribution waterfall. The UK-US Tax Treaty does not provide relief in this regard, because the US is authorised to tax its citizens at all times in accordance with domestic law. In principle, a dollar-for-dollar foreign tax credit may be available in the US in respect of UK tax liability when incurred, but uncredited UK tax can be carried back for only one year (and carried forward 10 years). It may therefore not be possible to obtain the benefit that the foreign tax credit is designed to achieve where the two tax liabilities arise in different periods. While the UK carried interest rules allow adjustments to be made to prevent double taxation, HMRC take the view that no relief is available for foreign taxes.
The government has announced that legislation will be introduced in Spring Finance Bill 2023 that allows an individual who is expecting to receive carried interest to make a voluntary and irrevocable election for their carried interest to be taxed in the UK on an accruals basis. We are still awaiting further detail of how this is intended to operate in practice. Whether the new election will actually permit claiming an improved foreign tax credit position in the US remains to be seen, as the new rules will need to be scrutinised from a US tax perspective. Namely, it is possible that the voluntary nature of the UK tax accrual or the comparability to the US realisation based system may call such a claim into question. The new election is expected to be available in respect of tax year 2022/23 and subsequent tax years.
No changes to Sovereign Immunity Exemption
The UK government has announced that, following the consultation on potential changes to the sovereign tax exemption, it has decided not to make any changes. As such, the UK’s sovereign tax exemption will continue to operate as it does now.
Helpful changes to the QAHC GDO condition
The government has made a number of helpful changes to the UK’s new Qualifying Asset Holding Company (QAHC) rules. In particular, it has made it easier for a fund entity to satisfy the ownership condition. In order to qualify for the QAHC regime, the QAHC must be held by 70% or more “good” or “Category A” investors. A “qualifying fund” is a Category A investor. As such, if a QAHC is wholly owned by a “qualifying fund”, the ownership condition will be met.
There are a few different ways that a fund can constitute a “qualifying fund”: the first requires the fund to meet the Genuine Diversity of Ownership (GDO) condition. The government has announced that it will make amendments to the GDO condition to make it easier for multi-fund arrangements (for example, funds involving feeders and parallel fund structures) to satisfy the condition. This will apply for the purposes of the QAHC regime, as well as the UK REIT and Non-Resident Capital Gains regimes. This change is expected to take effect from the date of Royal Assent to Spring Finance Bill 2023.
As currently drafted, only funds that constitute a collective investment scheme (CIS) can rely on the GDO condition. The government has confirmed that this will be expanded to include certain entities which would be a CIS if they were not bodies corporate. In particular, this is expected to ease concerns around funds constituted as Delaware limited partnerships, as it is not clear whether these meet the CIS definition due to the fact that they have separate legal personality. This change is expected to take effect retroactively from the date the QAHC rules were introduced (April 2022).
The government has also announced that the rules will be amended (with effect from the date of Royal Assent of Spring Finance Bill 2023) such that, upon making a separate election, a QAHC can hold listed securities and still meet the investment strategy condition. However, the QAHC will be taxable on the dividend income received in respect of such securities.
Pillar Two (global minimum tax) legislation
The government has reconfirmed that the UK’s implementation of Pillar Two, which seeks to impose a global minimum tax rate of 15% in groups with annual global revenues exceeding €750 million, will be introduced with effect from 1 January 2023.
In particular, the announcement covers:
- The multinational top-up tax, which is a new tax on UK parent members within a multinational group where it has an interest in entities located outside of the UK which are taxed below 15%.
- A domestic top-up tax, which will be charged when a multinational group’s profits arising in the UK are taxed at below 15%.
While exemptions are expected for investment funds where these entities are the ultimate parent of the group, the devil will (as always) be in the detail. The rules are not necessarily straightforward to apply in the investment fund context, particularly in multi-fund arrangements and in respect to asset holding companies. Asset managers should also consider whether this measure could impact the tax profile of portfolio companies. It is worth noting that these rules may give rise to reporting obligations, even if there is no additional tax to pay.
Planned Corporation Tax rate increase to go ahead
The UK government has confirmed that the previously announced rate increase in the main rate of corporation tax from 19% to 25% is set to go ahead (notwithstanding the fact that it was briefly cancelled in last year’s mini budget). Companies with profits of £50,000 or less will continue to be subject to the 19% rate. Companies with profits between £50,000 and £250,000 will pay tax at the main rate, reduced by a marginal relief. However, the lower rate and marginal relief will not be available for closely held investment holding companies.
