HMRC internal manual

Investment Funds Manual

IFM36335 - Disguised fees: The enjoyment conditions - special provisions for companies

The enjoyment conditions - special provisions for companies

ITA07/S809EZDB(6)-(10)

Special provision is made in relation to companies. This is because a fund management business could be set up as a wholly onshore corporate structure, with the fees and any carried interest arising from the underlying funds being charged in full to corporation tax. If, for example, an individual owned more than 50% of that business they would be connected (IFM36330) with the company and charged in full on amounts arising to that company but for this rule.

This would be the case even if the company was a genuine vehicle of substance carrying on the entire investment management trade, the profits of which are charged fully to corporation tax.

All the facts at the time must be considered, however any attempt to gain a tax advantage could result in the fees being chargeable to income tax under disguised investment management fees (DIMF) rules. For example, the use of structures that are artificially interposed between an individual and the management fees to access corporation tax treatment.

The rules are therefore modified in the context of corporate structures to ensure that the “corporate veil” is not pierced in such situations.

Exemption - enjoyment conditions (b), (c) and (d)
ITA07/S809EZDB(6)

If enjoyment conditions (b), (c) and (d) are met solely because the individual fund manager holds shares or an interest in the shares of a company, the condition will be treated as not met.

Example

A sum which has been classified as a disguised management fee (IFM36300) arises to a company which is not connected with A but in which A holds a number of shares.

The fact that the receipt of this sum increases the value of those shares that could be used to pay a dividend to A will not trigger a charge under enjoyment conditions (b), (c) and (d) in and of itself. However, if that company is part of a wider remuneration structure from which A receives or is entitled to receive any benefits otherwise than as a shareholder, enjoyment condition (c) will still be satisfied and A charged to tax.

Enjoyment condition (a) may also be met but this will only be true if the sum received by the unconnected company benefits the particular individual who is potentially subject to the charge, or a person connected with the individual. It will not be sufficient that the sum received benefits a group of unconnected individuals. For completeness, enjoyment condition (e) would not be met in this scenario unless A or a person connected with A are able to, in any way, control the application of any part of the sum.

Exemption - enjoyment conditions (a) and (e)
ITA07/S809EZDB(7)

Enjoyment conditions (a) and (e) are not met where a sum arises to a company connected with A if that company is chargeable to UK corporation tax in respect of the sum.

This exclusion will also apply where the company is a controlled foreign company (CFC) within the meaning of TIOPA10/Part9A, and it can take advantage of the “tax exemption” contained in Chapter 14 of those rules.

In effect this means that the CFC is liable to pay an amount of tax in its country of residence equal to at least 75% of the amount that would have been due if it had been chargeable to the tax in the UK. The tax exemption contains detailed rules as to how the comparison is to be undertaken. These rules are designed to prevent manipulation of the tax due in the country of residence. Guidance on these rules can be found at INTM226000+.

Furthermore if the company is not a CFC (for example because it is controlled by persons outside the UK), the exclusion can still apply if the conditions for the tax exemption in the CFC rules are otherwise met (for example, if the company were a CFC it would qualify for exemption because the tax it pays is equal to at least 75% of the amount that would have been due if it had been chargeable to UK tax).

Limitations of both exemptions
ITA07/S809EZDB(8) - (9)

Both the above exclusions are subject to strict limitations, to ensure that they only benefit genuine management structures. This way, if an individual tries to interpose corporate entities between themselves and their management fees in a way to circumvent the intention of this legislation, the exclusions offered at ITA07/S809EZDB(6) and (7) won’t apply.

Neither exclusion from the enjoyment conditions will apply if the sum arises as part of arrangements where the following two criteria are both met:

(a) It is reasonable to assume that, in the absence of those arrangements, the sum would have arisen to A or an individual connected with A.

When considering what is “reasonable” it is important to take into account all the available facts.

Where a UK based manager has a very small shareholding in the ultimate (often quoted) parent vehicle of a large multi-national corporate asset management group, it will generally be obvious that the sums which represent the management fee would not arise to them in the absence of those arrangements.

On the other hand, an individual manager or small management team interposing a corporate entity with no substance will be caught.

In between the two extremes it is harder to define a clear line where it will become reasonable to assume that in the absence of those arrangements, the sum would have arisen to A or an individual connected with A. The factors below, which are non-exhaustive, may help in considering what is reasonable:

  • What structures were used by the fund management house in relation to prior funds (this may not just be their immediately preceding fund);
  • Whether the company was put in place in response to advice to minimise a tax burden or achieve tax efficient co-investing funding;
  • Whether the fund management business operates (and has always operated) as a wholly corporate group;
  • Whether a company in the corporate group carries on a trade of providing investment management or advisory services on a commercial basis with a view to profit and the individual receives an arm’s length rate of remuneration from his or her employment by that company. That company has sufficient substance to carry on the management activity and actually does so i.e. with its own employees, contracts and other assets;
  • The size of the management team;
  • The international spread of the management team;
  • What happens when an individual joins or leaves the management team – both in terms of prior agreements and understandings, as well as legal agreements (if the expectation is that the manager will receive a reward which in any sense reflects or is calculated by reference to amounts which have arisen or profits which have accrued to the corporate).

The above list contains suggestions of what could be considered when deciding if it is reasonable to assume that a sum would have arisen to A in the absence of the arrangements. No factor is deemed to be decisive; the analysis depends on the facts and circumstances.

(b) It is reasonable to assume that the arrangements have as their main purpose, or one of their main purposes, the avoidance of a liability to pay income tax, capital gains tax, inheritance tax, or corporation tax.

This test does not require the purpose of the arrangements to involve the avoidance of the DIMF rules. Seeking to avoid any income tax, capital gains tax, inheritance tax or corporation tax advantage will be sufficient. In particular, HMRC understands that some of the structures set up historically by nom-domiciled fund managers were designed to manage their liability to inheritance tax rather than secure any income tax advantage and this will be sufficient to fail this test.

This test will be deemed to be met where the management fee is used (whether directly or indirectly) to make an investment in a collective investment scheme (ITA07/S809EZDB(9)). This will be the case even if there is, in fact, no tax avoidance motive to the arrangements in any sense. This responds to structures which were common before the DIMF rules were introduced which sought to meet fund manager’s co-investment commitments in a tax efficient way. Many of these structures sought to apply management fees which would otherwise arise to a fund manager to pay up his or her co-investment commitment.

While this provision (ITA07/S809EZDB(9)) is targeted at co-invest funding structures, please note this can include investments in any collective investment scheme, not just those managed by the individual in question. If taxpayers argue that the sums are not arising from a collective investment scheme in a way which undermines the clear policy rationale behind this legislation, HMRC will consider making a challenge, this includes applying the targeted anti-avoidance rules (ITA07/S809EZF) (IFM36600).