Carried Interest

Investment Manager Risks and Rewards

Corporate Finance & Restructuring

August 5, 2016

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Investment managers should consider the UK tax consequences of the new regime for taxation of carried interest and investment management fees, with the latest rules introduced in April. It is now timely to evaluate whether fee structures create tax risk for individual staff but it may also be an opportunity to take a fresh look at both fee and entity design to respond to growing investor challenge of the traditional “2 and 20” fund remuneration model and the evolving landscape of trading entity and individual taxation.


The remuneration of UK investment managers in private equity (“PE”) has historically been advantaged compared with other investment managers including hedge fund managers (“IMs”). IM remuneration is typically taxed as trading profits; while the “carried interest” returns allocated to PE managers have been taxed at significantly lower marginal rates as capital gains, reflecting the capital enhancement nature of their activity on the assets managed. In recent years, investment management fee structures emerged to take advantage of the beneficial tax treatment of carried interest. In response, HMRC introduced new rules to ensure that rewards for trading performance could not be effectively “disguised” as capital receipts, but would be taxable as income and the tax treatment of long-term investment returns as capital gains would be protected.

Disguised Investment Management

Fees and Carried Interest The Disguised Investment Management Fees (“DMF”) rules were introduced in April 2015 and further refined in 2016 with “Income Based Carried Interest” (“IBCI”) rules. Taken together the rules are designed to treat all investment management returns as trading profits subject to income tax, unless they are structured as carried interest and relate to investments held for an average period of 40 months or more. Carried interest as defined in these rules is specifically excluded from the income tax treatment of disguised fees, to allow capital gains tax treatment for genuine risk-related investments acquired on terms comparable with external investors. Under the new tax regime it is now possible for investment management returns with genuine commercial characteristics of carry, which relate to long-term underlying investments, to be structured as carried interest subject to tax as capital gains within the new statutory definition of carried interest.

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