Despair and Hope

A reflection on the 2009 budget

Originally published in the May/June 2009 issue

Stand back from the budget and consider its impact on the asset management sector, then, if it were a football match between the Treasury and the Industry, I think the score would be about 1 – 1. Neither side would want a replay. And there would be some lingering dispute as to whether the Treasury’s goal should have been disallowed.

The political aspects of the 50% headline tax rate, removal of personal allowances and attack on pension contributions for high earners have all been recorded and analysed in detail elsewhere.

For some these moves will simply confirm the “thin end of the wedge” concerns which they had following the non-doms £30k annual levy debacle and the mess around the response to the 10% BATR CGT rate on carry. In conjunction with the Government’s so far less-than-robust response to EU regulatory initiatives targeting the sector, this has all added to the feeling that wealth creation and entrepreneurship, particularly in the City, are no longer supported to the same degree as before.

In light of this the question of whether London is still the best location from which to conduct asset management activity is now formally on the board room agenda. There have been statements of intent to leave the UK from some high profile asset managers. And for every one of these there are many more organisations asking themselves – or more precisely their head of finance and tax – the same question.

Migration issues
So, let me start by addressing the migration debate first. Clearly, despite some important continuing tax advantages for the UK as an asset management location, the UK burden of taxation is in danger of becoming a potential impediment to business. This is especially the case for the more entrepreneurial owner or boutique asset manager, and let’s not forget the tightening of the remittance rules and inheritance tax on trusts provisions in recent Finance Acts, the rising employer’s NIC announced in the November 2008 pre-budget report, and the matching increase in the tax rate of dividends from April 2011.

In addition, the administrative burden of the UK tax regime is rising year on year with ever greater investigative and penalty powers for HMRC, and a constant stream of “targeted” anti-avoidance measures.

However migration takes many forms and raises many issues: before you start thinking about where to re-locate, and start drifting into thoughts of golden beaches or ski chalets, the big issue for any asset manager is whether you be able to continue to operate your particular business effectively from another location.

A big driver of this is literally likely to be the appetite of your senior people to relocate, either fully or partly. There are many reasons (family, schools, elderly parents, lifestyle, the love of warm beer) as to why one or more of your senior team may want to remain in the UK. The issue then becomes one of whether you can split the functions of your business and operate some functionality effectively from an offshore jurisdiction.

Typically, functions such as marketing, investor relations and capital introduction services are often considered to be so self-contained that they can be considered for relocation. Alternatively, it may be possible to look at the head office function or investment committee functions as being parts of the business which can be relocated.

Assuming the business issues can be addressed, the key tax issues to consider include:

• Can the functions and related assets and liabilities be moved out of the UK without triggering any UK tax costs?

• Where would those functions be moved to?

• What is the overall tax framework of the new location taking into account employee taxation, social security, VAT, statutory pension contributions, employer taxation, taxation of business profits, the existence of a comparable non-dom regime and overall wealth taxation framework?

• Will it really represent an improvement on the UK? If so, by how much? And how sustainable is the overall tax framework you may be adopting?

• What value would you put on the functions retained in the UK for transfer pricing purposes so that a modelling exercise can be undertaken to demonstrate the tax cost benefit analysis of the proposed move?

• What are the operating constraints that must be observed, if any, to make the offshore relocation “work”?

As with any re-structuring, once the decision has been made to re-locate the key issue becomes one of careful implementation and documentation. The devil in such plans is always in the detail and, with the UK tax authorities being more focused than ever on challenging tax structures on the basis of mistakes in their implementation, the saying “tax structures are for life and not just for Christmas” has never been truer.

Efficient reward
In terms of personal tax rates, the headline tax question will be what next for personal income and wealth taxation? In particular there has to be a question as to whether the disparity between an effective 51.5% income tax and NIC rate and an 18% CGT is sustainable especially in the context of the UK’s overall fiscal position.

Minds are already focused on the question as to how reward can be acheived in capital form rather than income form, especially given the absence of any holding period qualification for the CGT rate.

We expect to see many more employers offering employees the chance to take an interest in a asset which should yield capital gains returns or even a completely tax free return, for example, LLP interests and distressed assets. However, the plethora of UK employee tax anti-avoidance legislation which sits on the UK statute books means that this is a path which needs to be very carefully trodden.

Clearly people are going to review the whole logic of contributing to a UK pension plan: 20% (expected to increase to a 30%) tax on the way in and up to possibly 50% tax on the way out lacks a certain sense of balance in most people’s minds.

In addition, there are many employers around who are sitting on large tax losses so that the immediate need for a tax deduction for the employees reward payment may be less of an issue.

There are several possible responses to this situation. One response has been to look to create a synthetic pension plan using Employer Financed Retirement Benefit Scheme or an Employee Benefit Trust where contributions are made to an offshore vehicle to allow gross re-investment of return.

For those asset managers structured as LLPs, the differential between the headline personal tax rates of 51.5% and the headline corporate tax rate of 28% means that opportunities exist for the use of a corporate member of an LLP as part of an efficient tax planning framework.

Product choice
For the asset management sector, the budget represented another step towards a UK tax regime which addresses some of the competitive issues faced by the UK asset management industry. The budget announcements around the taxation of fund products followed on from a number of previous announcements and consultations, and fund managers and promoters will need to scrutinise the detail carefully, assessing the impact of the proposed changes on their business.
However, product choice is not only a matter of taxation. There is a broader backdrop of significant financial services industry challenges and changes, from which the asset management world is not immune, which will impact product design, choice and fund location.

There are significant regulatory and governance issues which are yet to fully play themselves out:

• the FSA’s focus on risk and reward structures

• the Walker review of banks’ governance would be extended to other financial institutions, including asset managers.

• continuing G20 discussions and wider political focus on tax avoidance and exchange of information.

• The Foot review of the Independent Review of British Offshore Financial Centres (which, in its interim report posed the unanswered question, “is there a level playing field between UK suppliers [of retail products] and those operating from the financial centres and, if not, is change necessary?”)

Perhaps of even greater significance are the draft regulations from the European Commission in relation to regulation of alternative investment fund managers within Europe. As currently drafted there is a real risk that there may be a period of up to three years during which EU based asset managers will not be able to market some or even all of their current fund range within Europe. Should this approach remain in its current form it will drive EU managers to consider whether they need to launch onshore regulated equivalents (if possible) of their current offshore fund ranges.

The main budget changes affecting product design are:

• The tax elected funds (TEF) regime will act to exempt certain streams of income from tax within a UK fund where the fund elects into the regime. Only those TEFs that satisfy a genuine diversity of ownership condition will be able to elect into the regime. Capital gains in a TEF will continue to be exempt from tax, as is currently the case for authorised investment funds. Distributions made by TEFs to investors will need to be streamed into two distributions – a dividend distribution and an interest distribution – and taxed accordingly. It is too early to tell how widely this election will be used or to what extent it may provide an onshore vehicle for replicating current offshore fund ranges.

• Trading versus investment clarification: the budget confirmed that legislation will be introduced from 1 September 2009 to provide that certain “white list” transactions undertaken by UK investment funds will be treated as investing for tax purposes rather than trading.

The Budget also announced that the legislation will also extend to UK-resident investors in ‘equivalent offshore funds’ (see later). The “white list” will, broadly, replicate the updated list of investment transactions used for the UK Investment Manager Exemption, and will apply to UK approved funds that meet a genuine diversity of ownership condition.

This list is broadly drafted and includes transactions in shares, loans and debt instruments, derivative contracts, money deposits, units in collective investment schemes and carbon emission credits.

• Reporting regime for offshore funds – a new reporting regime will be introduced as from 1 December 2009 and the “white list” of transactions will also apply in relation to the determination of reportable income for “equivalent” offshore funds.

This should be a major boost for those hedge fund managers who wish to market their products in the UK to UK high net worth individuals especially given that the disposal of interests in approved reporting funds will be subject to CGT at 18%.

It is not without coincidence that the upsurge we are seeing in UCITS III compliant products being issued by hedge fund managers comes against the above regulatory backdrop and the changing product tax landscape.

Asset managers stand to be potential beneficiaries from the overall fall out from the credit crunch, if the pitfalls and opportunities from the budget are carefully managed then the outlook on the product side should mean that a 1-1 draw is an acceptable outcome for asset managers.


Robert Mellor is a Corporate Tax Partner and is the Financial Services Tax Markets leader in the UK. In total, Rob has over nineteen years of tax experience mainly within the financial services sector. Rob has led PwC’s hedge fund and private equity tax teams within IMRE for the last five years and this year has taken a lead in establishing and driving the European alternatives tax network. Rob began his tax career at the UK Inland Revenue before joining PwC in November 1998.