Carried Interest
The Labour manifesto promised to cease taxing carried interest as capital. It made good on this promise on Budget Day but appears to be falling short of imposing full income tax rates on carry. This will offer at least a limited comfort to the investment management industry. Although, detail is lacking, it looks like carry will instead be taxed in the longer term at 32.6% (or 34.6% if subject to National Insurance contributions (NICs), which is unclear). No exemptions have been offered, such as a much speculated upon co-investment safe harbour, but as full implementation is delayed to April 2026, there is potentially still scope for this to change.
As an interim measure, the current regime will continue to apply until April 2026 with rates increased to 32% from April 2025. From April 2026 carry will be taxed within the "income tax framework, with a 72.5% multiplier applied to qualifying carried interest'. There is much here that is unclear, not least what will constitute "qualifying carried interest" or how this will interact with the NICs regime. Taken at face value this would give an effective rate of 32.625% (72.5% of the additional rate of 45% and ignoring NICs).
To what extent the investment community is able or willing to absorb this rate increase remains to be seen. There had been widespread fears that this change (together with the changes to non-dom rules also announced today) would see an exodus of PE houses from London. A comparatively modest 4% rise may be low enough to prevent this but this will remain to be seen.
In the meantime, it will be essential for those in the industry to keep an eye on detailed legislative proposals as these become available. The definition of qualifying carried interest is likely to be key, as investment managers may be able restructure either their funds or their portfolios either to fall inside or outside this definition (depending on which turns out to be more beneficial) in advance of the changes.
Legal advice will be key to any such structuring, so please contact the DWF tax team to discuss further.
Enterprise Investment Trust and Venture Capital Trusts in the Budget
The Government confirmed in the Autumn Budget 2024 that the Enterprise Investment Scheme ("EIS") and Venture Capital Trust ("VCT") schemes will be extended to 2035.
Initially introduced in 1994 and 1995 respectively, this will mean that the reliefs available to individuals and VCTs will have been available for forty years, facilitating access to external sources of finance for small, young businesses.
We first wrote about the extension to the VCT scheme in early October 2024, and you can find out more about the scheme's qualifying conditions and incentives in our article here.
Capital Gains Tax, Business Asset Disposal Relief and Investors' Relief
An increase in the rates of Capital Gains Tax ("CGT") paid by individuals and trustees was widely expected, given that the Government was silent on it in its election manifesto. CGT is paid on any gain arising on the disposal of capital assets, subject to certain exemptions, such as for your main home, and an annual £3,000 allowance.
The lower rate of CGT has increased from 10% to 18%, and the higher rate of CGT has increased from 20% to 24%. These rates now match the CGT rates for disposals of residential property. The rate increases take effect from Budget Day, and so apply to disposals on or after 30 October 2024. We expect that there are plenty of relieved sellers who completed their sales late on 29 October.
Sellers should note that the Government will introduce anti-forestalling rules that apply to unconditional, but uncompleted contracts, that were entered into before 30 October 2024. To benefit from the "old" rates of CGT, parties to such contracts must prove that:
- they did not enter into the contract for sale and purchase for the purpose of taking advantage of the rules that deem a disposal to occur when a contract becomes unconditional, rather than at the date of completion; and
- if the parties are connected, they must be able to demonstrate that contract was entered into for commercial reasons.
There will also be changes to the CGT reliefs of Business Asset Disposal Relief (BADR) and Investors' Relief (IR). The rates of CGT applicable to both reliefs will increase from 10% to 14% from 6 April 2025, and then to 18% from 6 April 2026. The lifetime limit for IR will also be reduced to £1 million for all qualifying disposals made on or after 30 October 2024, brining IR in line with BADR.
The increase in rates of CGT is, on the face of it, not as dramatic as expected. Prior to Budget Day, there was speculation that the increases could go as far as equalising the CGT rates with the rates of income tax, i.e. up to 45%.
The Office of Budget Responsibility forecasts that this package of changes will raise an additional £90 million this tax year rising to £2.5 billion per annum by 2029/30. This is due to the fact that a relatively small proportion of the population (369,000 people in 2022/23) pay CGT. Together with the other major tax rises announced in the Budget, CGT is likely to be viewed a just one of a number of tax rises in the biggest tax-raising budget since 1993.
The anti-forestalling measures set out above should be considered carefully. Sellers should take advice if they are unsure whether their pre-Budget sale falls within the old CGT rates, and also if they are considering a capital disposal during the remainder of this tax year. DWF can help with this so please do not hesitate to get in touch with your usual contact.
Employee Ownership Trusts
As part of the Budget 2024, the Government has announced a number of changes to employee ownership trusts ("EOTs"). These changes follow a consultation on EOTs that took place between July and September 2023, which DWF took part in. A number of the changes announced today were expected, as they follow the outcome of that consultation, but there are some key points to be aware of.
EOTs were originally introduced by the coalition government in 2014 to encourage wider employee ownership. EOTs provide CGT relief for owners of companies selling the shares of their trading company into a trust set up for the benefit of the company's employees. A number of requirements must be met for the relief to be available. (It is worth noting the relief is a relief for the sellers, but is really a deferral of tax as any gain will ultimately come into charge on the trustees if the EOT sells the business in the future.)
We have advised company owners, trustees and third party funders on EOTs structures and we have seen them grow in popularity after a relatively slow start.
The consultation in 2023 sought to make some changes to the EOT rules to ensure that the legislation operated as the Government had intended.
The majority of the changes were anticipated but there were a few surprises. While we do not have the draft legislation yet, the announcements set out the following changes.
- Former owners of the company (or persons connected with them) are restricted from retaining control of the company after a sale to an EOT, by controlling the EOT itself.
- The trustees of the EOT must be UK resident at the time of disposal to the EOT. This is to ensure that the EOT relief acts as deferral of tax rather than an exemption by allowing non-UK resident trustees to realise a gain by selling the shares in the company, which would have escaped UK CGT.
- Finally, there has been some doubt as to how contributions to the EOT from the company should be treated for tax purposes, as this is not dealt with in the legislation. It was therefore routine for EOTs to obtain a non-statutory clearance from HMRC that the contributions would not be taxed in the hands of the trustees. The response from the Government confirms that these contributions will be treated as distributions, but they will be tax free if the contribution is to repay the sellers for the shares in the company and meet the costs of acquiring the shares (including stamp duty and reasonable interest on deferred consideration).
These three changes were largely expected.
In addition, a number of other changes were made that were contemplated by the consultation but were less widely considered.
- Employees of companies owned by EOTs can receive a "bonus" of up to £3,600 each year that is tax free (but not free of National Insurance contributions). This bonus must be paid to all staff on the same terms (with some limited exclusions). The changes from today will allow bonuses to be awarded to employees but not to directors. This provides some flexibility and may allow the bonuses to be paid to the less well remunerated staff rather than to the directors of the company.
Before 30 October 2024, CGT relief that sellers enjoy will be withdrawn if the company fails to meet the qualifying conditions for EOT before the end of the tax year following the tax year in which the disposal occurs. This withdrawal is now extended if the conditions are not met before the end of the fourth tax year following the tax year of disposal.
This is quite a significant change and one that could potentially cause problems. If the seller does not control the business after the sale, which it cannot, and now under the changes announced today it cannot control the EOT; how does the seller ensure that the company continues to meet the necessary conditions and does not trigger a claw back of the seller's CGT relief? This is already a problem for sellers but the problem is now more of an issue as the period is extended significantly
The way in which this is typically dealt with is that most sellers require the trustees of the EOT to provide an indemnity to them to cover the CGT if the EOT CGT relief is withdrawn as a result of failing these conditions. This will become more important for sellers, and potentially more onerous for trustees, who may suffer a "dry" tax charge.
- The new legislation will also require that the trustees must take "reasonable steps" to ensure that the consideration paid to acquire the company's shares does not exceed the market value of those shares. It is not clear what steps these may be or what HMRC will consider is "reasonable", but trustees should now have any valuation reports addressed to them as well as the sellers. If the trustees do not take reasonable steps then the disposal may not qualify for relief and the trustees may be taxed on the distributions from company.
We think that this is probably a sensible change as EOTs are intended to allow the business to flourish for the long term under employee ownership and EOT relief is not intended to weigh down a company with long term debt. Valuation is obviously a crucial consideration when any part of the consideration is funded by third party debt secured on the EOT assets and the company. It should also probably be welcomed by sellers who genuinely want to pass the benefit of the business to its employees and who have technically run the risk of an employment related securities charge if the company's shares were sold to an EOT for more than market value.
- Finally, in an administrative change to the rules, that is effectively retrospective, for the 2024/25 tax year onwards, sellers of shares to EOTs must include details of the consideration they have received for the shares and the number of employees of the company at the date of disposal when making a claim for EOT CGT relief in their self-assessment tax return. This is intended to allow the HMRC to, "better monitor and evaluate the relief". This will affect anyone who sold their shares to an EOT since 6 April 2024.
At DWF we have extensive experience of advising sellers, trustees and funders on EOTs. If you would like to discuss this please contact Jon Stevens.
Creative Tax Relief
The Government has, as part of the Autumn Budget 2024, committed to an estimated £15 billion in tax reliefs for the UK’s creative industries over the next five years. The current Government will retain these measures and it has committed to upholding those measures that have already been legislated.
Starting from 1 April 2025, an enhanced audio-visual expenditure credit will be available for UK independent films at a rate of 53% of qualifying film production expenditure. This credit is designed to incentivise film industry output on qualifying projects with budgets under £15 million.
Furthermore, the tax relief for visual effects costs in film and TV will increase to 39% (up from 34%), and the cap on qualifying expenditure for visual effects costs will be removed entirely.
Other measures for the creative industries include making tax reliefs for theatres, orchestras, museums, and galleries permanent at 45% for touring and orchestral productions and 40% for non-touring productions. These rates were due to reduce to between 20% and 25% by 2026 but will instead be maintained at these higher rates.
