“A riddle, wrapped in a mystery, inside an enigma”
By Michael Beart, Director and Marie Barber, Managing Director, Duff & Phelps
Published: 12 July 2017
For those acquainted with the topic, Winston Churchill’s now famous words taken from his 1939 BBC broadcast provides a more than fitting description of the Disguised Investment Management Fee (DIMF) legislation. More than two years after coming into force, many taxpayers (and also a great number of advisors) remain confused as to the full implications and intentions of the DIMF legislation despite exposing investment managers to potentially crippling personal tax liabilities.
The complexity of the DIMF legislation, combined with its staggered introduction and key amendments, has left many managers unsure about how and when it applies. Furthermore, the potential to cut through typical non-domicile protections, corporate structures and transfer pricing positions is perhaps one of the most fundamental and misunderstood areas to the legislation. Put it simple terms, it can operate such that individuals are taxed as if they personally receive their share of management and performance fees directly in the UK regardless of the commercial position and intervening corporate realities. With new guidance anticipated in 2017 we would expect HMRC to start to use the new legislation to its full potential and raise additional tax revenues from the asset management industry.
The DIMF legislation is a piece of targeted tax avoidance legislation focused on the asset management sector and first came into force in relation to fees arising from 6 April 2015. The legislation is part of a wider overhaul of the taxation of investment managers in the UK and extends equally to the hedge fund industry.
The legislation imposes an income tax charge on fees that are deemed to arise to an individual performing investment management services in a tax year from an investment scheme and/or managed account. The deeming provisions operate such that a fee arises to an individual if they receive it directly or if certain ‘enjoyment conditions’ are met. The introduction of the enjoyment conditions is one of the key amendments that widened the scope of the legislation. Should the enjoyment conditions be met, the legislation provides for some exemptions, however the exemptions are themselves barred in certain situations, for example where the fees are used to reinvest back into the fund. As such it is paramount to step through the legislation from start to finish. However, on undertaking the analysis many taxpayers may find themselves uncertain as to how to interpret the legislation and are left guessing as to the intention behind certain provisions. The net result in some cases will have a considerable impact on commercially driven business models.
Despite DIMF issues stemming from the corporate structure adopted, the responsibility to disclose and pay any tax liability rests with the individuals providing investment management services, not the business. The risk is that addressing the legislation could fall between the gaps in the relationships between corporate and personal tax advisors. Quite understandably many personal advisors who should be including DIMF disclosures in the individual’s tax returns will not have the full understanding of the corporate structure required in order to undertake the analysis.
Additionally, the existence of a potential personal liability, requires individuals to exercise their judgement as to whether the legislation applies when completing their own personal tax returns. This creates an extra complication that different individuals working alongside one another in the business could file differently, i.e. one could make a disclosure and the other may not. There is no mechanism to ensure consistency across all such individuals with respect to what is disclosed to HMRC.
HMRC first published guidance on the DIMF legislation in 2015, however despite numerous amendments to the legislation it has yet to be officially updated, even though HMRC acknowledge it does not cover material points amended (e.g. the enjoyment conditions). Draft guidance covering the amendments was informally published for comment on 21 October 2016 but cannot be relied upon and a final revised version of the guidance is expected to be released towards the end of Summer 2017.
What it is possible to infer from the guidance is that HMRC consider that a wide range of factors are relevant to determining when a fee arises to an individual, such as equity ownership, voting rights, the use offshore structures and trusts. The original guidance suggested some ‘safe harbours’ for genuine corporate management vehicles with sufficient substance but disappointingly these have not been retained as the legislation has been amended. Instead they provide more indication as to their views on topics such as when it is reasonable to assume an amount would have arisen to an individual. Rather ominously it states that HMRC will pay particular attention to structures which rely on claiming that investment management activities are partially performed by a vehicle outside the UK in a low (or no) tax jurisdiction and closely examine the substance of the purported offshore activity, in other words, the transfer pricing of the transactions in place.
Interaction with other legislation
It is important to note that the DIMF legislation operates independently to a number of other key pieces of tax legislation applicable to the industry. Managers with international structures may be required to consider both transfer pricing and diverted profits tax (DPT). However, both transfer pricing and DPT have small and medium sized enterprise (‘SME’) exemptions, but DIMF does not have an equivalent protection. Nor for that matter does the investment management exemption (‘IME).
Equally the non-domicile regime that many in the industry benefit from provides no protection from the DIMF legislation as it treats all amounts arising to individuals as part of their UK trade. Furthermore, it is not clear how this interacts with the new tax rules for non UK domiciled individuals. DIMF also has the potential to apply to non-resident individuals if they are providing services in the UK.
Similarly, it is unlikely that protection from a DIMF charge will be available under the various double tax treaties that the UK is party too. Where part of the structure is based in other EU countries, an argument may be considered under the EU treaty freedoms and in particular, the free movement of capital, as the DIMF legislation may impede non-resident investment management companies attracting capital from the UK and vice versa. However, making such an argument could be a long and costly affair and is more likely to fail than succeed.
Action to be taken
Given the wide and complex implications of the DIMF legislation investment managers need to review their arrangements and assess whether the legislation applies. Seeking the support of a specialist tax QC in reaching a conclusion on the legislation is an increasingly popular theme and provides additional support for the conclusions made. However, taxpayers shouldn’t necessarily think the conclusions reached will be positive.
As best practice, it is important for managers to review the position annually, at the end of each accounting period, and understand how to practically manage the tax risk for their business and individuals involved in performing investment management functions. A plan of action should be developed at both the corporate and individual level, as consultation may be vital for achieving a consensus. Where the legislation has a material impact and is inadequately covered in the guidance, taxpayers may consider approaching HMRC to confirm the position. In a world of increased scrutiny and transparency, it is important for managers to take prompt action, review their affairs and consider the implications of the updated guidance once it is released later this summer.
To contact the authors:
Marie Barber, Managing Director: Marie.firstname.lastname@example.org
Michael Beart, Director: Michael.email@example.com