THE THREAT FROM THE CURRENT TAX ENVIRONMENT

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THE THREAT FROM THE CURRENT TAX ENVIRONMENT
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• Taxation of Management Equity
• Revisiting the MOUs
• The 10 percent tax rate

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Taxation and Management Equity

• At least one case listed the hearing before the
  special commissioners in the Autumn.
• HMRC have claimed that a substantial part of the
  proceeds of sale of management shares should be
  taxed as employment income under Chapter 4 Part 7
  of the ITEPA even though a s.431 election was
  made.

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Revisiting MOUs

• Senior HMRC official stated at a public
  conference that both MOUs should be revisited.
• This will be done with full consultation with the
  BVCA and other interested parties.

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The 10 Percent Tax Rate

• Applies to incomes of between 0 and 2150 or,
  according to the Press, without limit if you are
  a private equity fund manager!
• It is believed that the question of carry will
  crop up during the discussion on the carry MOU
  but the BVCA position is likely to be that we
  acknowledge that carry proceeds are prima facia
  taxable as employment income but by paying the
  full unrestricted market value for carry on
  acquisition and making a s.431 election carried
  interest holders properly move out of the
  restricted securities regime.

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The 10 Percent Tax Rate

• HMRC and the Treasurer are aware that major
  private equity centres such as the US, France and
  Germany tax carry at capital gain rates (subject
  to certain conditions) and indeed France and
  Germany have moved in that direction partly as a
  result of competitive pressure from the UK

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The Future

• The position should be a lot clearer in the
  autumn and something may be included in the
  pre-budget statement in November.

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PRIVATE EQUITY FUND INTERESTS HELD THROUGH TRUSTS
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Background

• Trusts were and are used quite frequently for
  holding carried interests in private equity
  funds.
• 1998 to 2003 - they were used to get round the
  application of the "conditional share rules".
• Post 2003 - trusts used less frequently but are
  used if there are other tax reasons why
  individual executives should not be in
  partnership with each other e.g. to avoid being
  associated or connected in other contexts.

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Background

• Non-domiciled executives still use trusts to hold
  carried interest and co-investment.
• As non-resident trustees are not liable to
  capital gains tax even on the sale of UK assets,
  the gains on carried interest are not taxable and
  the proceeds of such gains can be distributed to
  foreign domiciled beneficiaries free of tax and
  can be paid to the UK.

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Background

• Finance Bill 2006 has made radical changes to the
  taxation of trusts.
• Although these changes were not aimed at carried
  interest trusts in particular, there are
  situations which need to be looked at if such
  trusts were used by non-domiciliaries.

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Main Impact Of The Changes

• The changes mean that, subject to certain
  transitional rules, all life time trusts are
  taxed under the discretionary trust regime which
  means that
• entry charge of 20 for transfers above the
  available nil rate band
• periodic charge on each ten year anniversary of
  6 of the value of the trust fund above the then
  nil rate band and
• exit charge of up to 6 depending at which point
  during a trusts ten year cycle the exit occurs.

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Should I create a new Trust or add property to an
existing Trust?

• If non domiciled and non deemed domiciled - OK if
  non UK property
• If domiciled or deemed domiciled - no unless
  within nil rate band

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Case Study 1 Carried Interest the facts

• A UK resident/ordinarily resident but non-UK
  domiciled settlor.
• Pre-Budget offshore trust.
• The carried interest had little value when
  originally settled, but now shows significant
  unrealised gain and is held on discretionary
  trusts.

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Case Study 1 Carried Interest the good news

• There is NO CHANGE!
• The new taxation rules for trusts do not affect
  this scenario in any way.
• The old tax treatment continues.
• Check situs of carried interest.

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Case Study 2 Carried Interest the facts

• UK resident and domiciled settlor.
• Pre-Budget discretionary trust.
• The carried interest had little value when
  originally settled, but now shows significant
  unrealised gain.
• It is no longer possible to avoid an impending
  ten-year anniversary charge by appointing an IIP
  before that anniversary.

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Case Study 2 Carried Interest Planning options

• Leave the trust untouched and pay the 6 ten-year
  anniversary charge on the value of the carried
  interest.

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Case Study 2 Carried Interest Planning options

• Appoint the carried interest out to the settlor
  prior to the first ten-year anniversary charge.
• For IHT purposes, reliance may be placed on the
  no entry charge, no exit charge principle.

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Case Study 2 Carried Interest Planning options

• However the gain can be held over on an
  appointment by the trustees to the settlor this
  delays any CGT charge until a subsequent disposal
  by the recipient.
• The appointment out will prejudice the taper
  relief position for CGT unless and until the
  settlor has held the carried interest personally
  for a period of two years.

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Case Study 3 Co-investment Interest the facts

• A UK resident and domiciled settlor.
• Pre-Budget life interest trust - IIP trusts for
  the settlor, followed by IIP trusts for the
  settlors spouse, with the remainder to the
  settlors children on conventional childrens
  trusts.
• The co-investment interest shows significant
  unrealised gain.

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Case Study 3 Co-investment Interest pre-Budget

• An IIP trust was usually favoured over a
  discretionary trust in this situation because the
  trust required significant initial funding in
  order to acquire the co-investment interest and
  the settlement of these funds would otherwise
  have been an immediately chargeable transfer if
  the settlor had established a discretionary
  trust.

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Case Study 3 Co-investment Interest Planning
options Leave the trust as is.

• If the settlor dies on or after 6 April 2008
• the IIP acquired by his spouse will not qualify
  for the spouse exemption from IHT 40 charge
• co-investment will be immediately subject to the
  discretionary trust regime BUT
• there will be a tax free uplift in the base cost
  of the co-investment for CGT purposes.

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Case Study 3 Co-investment Interest Planning
options Amend the trust.

• Amend the trust so that, on the settlors death,
  the assets vest absolutely in the settlors
  spouse and, failing which, in the settlors
  children.
• If the settlor predeceases his spouse, the spouse
  exemption from IHT is available and there is a
  tax free uplift in the base cost of the assets
  for CGT purposes.
• The settlors spouse may then make outright gifts
  to the children with PET treatment.