The Finance Bill 2014 is scheduled to be enacted next month. Perhaps one of its more anticipated consequences is its final address to the dilemma of deferred remuneration under the AIFMD. Though the public is not short of guidance papers from HMRC on the topic, we present a summary of the issue and its hopeful resolution.
Casting back to last year, the implementation of the Alternative Investment Fund Managers Directive (AIFMD) has meant that those qualifying as full-scope alternative investment fund managers (AIFMs) must adopt AIFMD remuneration rules and some of them must apply what are known as the pay-out process rules effective as of the following performance period following authorisation. Topical for its rather unsavoury impact on the remuneration of key staff in AIFMs, one rule requires at least 40% of a partner’s variable remuneration, which includes performance fees and carried interest, to be deferred over a period appropriate to the life of the managed fund (60% in cases where the variable remuneration is deemed a “particularly high amount”). Another such rule imposes a minimum of 6 months retention on any variable remuneration paid as AIF shares or equivalent. Aside from being what many participants construe as a heavy burden, the tax treatment on the allocation of both deferred remuneration and retained AIF shares has not been clear until last September.
Individual members of limited liability partnerships (LLPs) have traditionally been taxed on trading profits as they arise in accordance with Chapter 2 Part 2 of the Income Tax (Trading and Other Income) Act 2005 (ITTOIA). Furthermore, such allocations will also attract a maximum of 9% Class 4 National Insurance Contribution (NIC). In applying this rule to the above mentioned pay-out process rules, individual members would be liable for tax and NIC in a given year for a significant portion of variable remuneration not yet paid out or vested. The treatment does not come as a surprise, as the concept of deferred remuneration is not exactly a new phenomenon and private equity fund managers would most likely be well acquainted with the mechanism. However, a tax on a large portion of compulsorily deferred remuneration does give cause for concern.
Part 3 of the Finance Bill 2014 has now introduced two options under which members of an LLP may elect to treat their deferred remuneration on a given year. Members of an LLP may now either elect to apply income tax as explained above or alternatively, apply the new ‘net of tax deferral’ scheme outlined in Part 3 of the Finance Bill 2014. Under the ‘net of tax deferral’ scheme, a member of the LLP may elect to allocate a part or all of its deferred remuneration to the LLP, on which the LLP would be liable to pay the additional rate of income tax (45%) with no reliefs of allowances available to set off against it. On the year on which the profit is paid to the member, the member would be liable for both NIC and personal income tax on the initial distribution – though the personal income tax liability is eligible to be netted against a tax credit from the tax amount initially paid by the LLP.
The ‘net of tax deferral’ scheme raises an interesting question. One might ask whether this scheme might also apply to income derived from UCITS for a fund manager managing both an AIF and a UCITS. At the moment, though Part 3 of the Finance Bill 2014 specifically targets income derived from the ‘AIFM trade’ of an ‘AIFM firm’ – one would expect that income derived from UCITS will be included in the Finance Bill since the to-be-approved UCITS V aligns remuneration requirements for UCITS on the AIFMD requirements.
Ultimately, while the Finance Bill will commence enactment next month, AIFMs are reminded that the AIFMD remuneration code needs not be implemented internally until the start of the first full remuneration period after authorisation. Of course, participants are urged to give themselves enough time for their remuneration structuring and tax planning in advance if they have not done so yet.