HMRC is increasingly focussing on the tax affairs of investment management businesses, particularly those structured as LLPs. We discuss below two particular areas of HMRC interest, and the strategies that businesses should be considering in order to best position themselves to deal with such interest.
The present (and future)
HMRC introduced the ‘salaried member’ rules in April 2014. These rules required LLPs to look at each of their individual members, and determine whether each member should be treated as self-employed or as an employee for UK tax purposes (with the corresponding differences in the application of the tax and national insurance regimes), by applying three separate tests. The tests involve considering whether:
LLPs will have analysed the position of their members in 2014 when the rules were introduced. However, HMRC expects (and the rules require) further analysis to be undertaken on a regular basis, at least annually and also when the arrangements in place as between members change (for example upon the admission of a new member).
Particular situations to watch out for might be where an individual has been given an element of guaranteed remuneration after April 2014 (where such guarantee would be treated as “disguised salary”) or where there have been promotions or demotions such that individuals who previously had significant influence might have lost such influence. In addition, where the LLP set up a management committee, has that committee met as frequently as was envisaged, and is that committee discussing all of the matters it was supposed to discuss? To the extent this has happened, have minutes and papers reflecting those discussions been retained, and can they be produced?
HMRC is now beginning to meet with LLPs to go through their interpretation of the salaried member rules and test the conclusions which were reached. Businesses should reassess their compliance with the rules in advance of any such meetings, and ensure that they continue to actively monitor such compliance going forward. Given that the principal target of the salaried member rules when they were introduced was professional services firms, it seems somewhat strange that asset managers appear to find themselves at the head of the queue when it comes to an assessment of compliance, but that appears to be the current position.
We also understand HMRC may be considering revising aspects of the guidance last issued on 27 March 2014, including revisiting a number of the examples contained in that edition of the guidance on which affected LLPs have sought to rely, so managers would be advised to review the approach taken in categorising their members in anticipation of any such revisions.
HMRC is also looking closely at historic remuneration arrangements, in particular those which involved the use of a “special capital” or recapitalisation arrangement to implement a deferral arrangement for individual LLP members that created an alignment of interest between those members and fund investors in line with regulatory best practice and investor demands. At their most straightforward, such arrangements involved an allocation of profits to a corporate member of the LLP management business. The after-tax proceeds of such an allocation were typically re-invested by way of special capital contribution to the LLP, with the LLP investing in relevant funds that it managed. After a certain period, and subject to certain performance and forfeiture conditions being met, the relevant capital interest, representing interests in the relevant funds, would be reallocated to certain individual members of the LLP and could then be withdrawn if a member wished. In some cases, the fund investments were made by the corporate member to address regulatory capital and other considerations.
Many of these arrangements became less attractive due to the introduction of the mixed membership partnership rules in April 2014, which created a potential upfront tax charge for relevant individual members that was not aligned with when those members might be able to withdraw relevant amounts from the LLP (assuming the relevant performance and forfeiture conditions were satisfied and subject to fund performance in the interim period). Managers have therefore had to revise their deferral arrangements to maintain the commercial objectives underpinning these.
Despite these changes, we are aware of HMRC challenging historic arrangements on a number of grounds. HMRC have a series of technical (and less technical) arguments as to why the tax analysis contended by the taxpayer is not correct. HMRC is also challenging the implementation of the arrangements in certain cases (which involves an examination of all relevant documentary communications around the arrangements, including emails, and a consideration of whether the arrangements were operated in practice in line with the commercial objectives originally proposed).
HMRC’s current strategy appears to be to gather as much information from different taxpayers as possible on the arrangements that have been implemented, whilst protecting any claims HMRC might think it has from becoming time barred by opening enquiries into the relevant tax returns or issuing discovery assessments (both against LLPs and relevant individual members) where such returns are closed. On the basis that at least some taxpayers will not settle the matter without litigation, HMRC may be searching for a “bad facts” case to bring before the courts, which, if HMRC wins, would be used to encourage taxpayers to settle (in full) regardless of how well those other taxpayers had operated their arrangements in practice.
Taxpayers who have implemented such arrangements should be evaluating their implementation of the arrangements and considering how they wish to deal with HMRC’s enquiries into those arrangements if and when they arise, whether on a consensual basis or through litigation, as well as associated matters such as how to protect their ability to reclaim any corporation tax paid by the corporate member if HMRC is ultimately successful in challenging the arrangements.
And more to come?
In addition to these changes, managers are also faced with increased scrutiny from HMRC in areas such as the recently introduced disguised investment management fee rules (and the ongoing extension of these to capture “income-based carried interest”) which can affect international management structures adopted by managers, transfer pricing and diverted profits tax. These, together with developments such as the corporate facilitation offence and a new landscape for large business compliance, may mean an unsettled outlook for many, at least until the latest revisions to the UK tax landscape for asset managers have bedded down.