UK clarifies carried interest taxation rule proposals

The UK government has defined long-term investment activity as an average holding of four years in its changes to how carried interest is to be taxed.

The draft legislation follows announcements in the UK chancellor's autumn statement, where the rate of tax on carried interest was hiked up from capital gains to income. However, the announcement caused confusion for the private equity industry as an exception was made for funds active in "long-term" investments. The UK government has now confirmed that long-term investment activity is defined as an average holding period of four years or more.

The legislation, due to come into effect in April, proposes that funds with an average holding period of less than three years will be taxed on an income basis; those with average holding periods of three to four years will see carry taxed with partial capital gains treatment; while those with average holding periods of more than four years will be taxed as capital gains.

The proposed measure would however not impact on co-investments made in the fund by fund managers.

Shrinking holding periods
unquote" ran the figures on its proprietary database to form an idea of how these changes could impact the UK buyout market. The findings revealed that for portfolio companies exited in 2013, 2014 and 2015, average holding periods came in at 6.9 years, 6.2 years and 5.1 years respectively.

For UK buyout exits completed between 2013-2015, 18% of deals were held for less than three years, while 12% of transactions were held for three to four years – meaning that potentially 30% of divestments carried out in the last two years would see carried interest charged at a higher rate of tax.

Encouragingly, 11% of exits were held for four or five years, 49% were held for 5-10 years, with the remaining 10% held for more than 10 years – meaning 70% of UK buyout exits done in the last two years would not see changes to tax on carried interest.

HMRC has proposed determining funds' average holding periods by looking at the mean investment period for all investments, if portfolio companies are exited in stages – through refinancing or partial stake sales for example – each stage will be treated as separate investments made at the same time for tax purposes.

Industry trade body BVCA has responded to the proposal, arguing that the average holding period should be three years rather than four in order to account for the impact of economic cycles. The BVCA will continue to work with the government to see the current proposals relaxed.

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• Topics
• Regulation
• UK / Ireland
• UK Government
• tax