The Employment-Related Securities regime is very broad. It includes shares and other securities (including units in a collective investment scheme) acquired by an individual where the right or opportunity to acquire the security is available by reason of employment.
This means that Carried Interest (and also the right to acquire co-investment) issued to employees or directors of a fund manager or investment advisers are generally treated as ERS. This would also include Carry acquired by salaried members and can include members of a partnership who hold directorships with other entities in the group/fund structure (such as the director of a portfolio company). As such, the scope of people within the ERS regime is often wider than people initially consider.
Whilst carried interest comes within the scope of ERS HMRC’s platform and guidance were not well designed for this type of asset and there can be particular complexities in reporting. As HMRC has a continued focus on this sector it is important any reporting is done correctly. We have experience in reporting these types of assets to HMRC and bringing clients’ affairs up to date where needed.
The deadline for filing the ERS return is 6 July. As such, it is important that all fund managers review their arrangements in advance of the deadline as there are automatic penalties for late or inaccurate filing, starting with a £100 penalty for a late return, with additional increasing penalties if the return remains outstanding for more than three months. In addition, if the return contains inaccuracies, HMRC can impose penalties of up to £5,000 per return.
What needs to be reported?
Before an ERS return can be prepared, the ERS scheme must be registered with HMRC. It is important to note that an ERS return can’t be submitted unless the scheme is registered; as such, all schemes must be registered with sufficient time for HMRC to provide a reference number in advance of the 6 July deadline. We would recommend all schemes are registered by 1 June.
- The employer must submit an ERS return in respect of all ERS schemes, including carried interest arrangements
- HMRC provides a template for submitting the ERS return. In relation to the carry, the ERS return will include the acquisition date of the carry, the total interest acquired, and the amount paid for the carry
- The return must be submitted each year, even if no new ERS has been acquired/granted in the period. In years with no activity, a nil return is submitted.
ERS considerations for carried interest
Most people will be awarded the carried interest at the start of the life of the fund. This means they’ll come within the safe harbour set out in the 2003 memorandum of understanding between the BVCA and the Inland Revenue (as HMRC was then known). It states that:
- If a carried interest is acquired before the fund makes its first investment, the initial unrestricted market value (IUMV) of the carried interest shall be taken as the amount actually paid for it
- If a carried interest is acquired after the fund has started making investments, then IUMV will remain equal to the price paid if it can be shown that the aggregate value of the fund’s investments has not increased above their aggregate acquisition cost at that time. This will need to be considered case by case.
As such whilst there is normally there is no tax due on a carried interest awards at this time and no valuation is required, it is important that consideration is given to making a s.431 election (which has a strict 14 days limit). The s.431 election ensures that the carried interest is taxable as a capital gain in the future, rather than at income tax rates.
Carried interest may be awarded at other times, such as to a new joiner, or there may be an increase as a result of a reallocation of a leaver’s carry points.
In these circumstance it important to consider the value of the carry. As the carry is an interest in a collective investment scheme, it is likely to be considered a Readily Convertible Asset and tax under PAYE at the time of award.
Even if the carry would appear to have a very low or possibly negligible value (i.e., if there have been no exits or still under the hurdle), it is important that the value of the carry is considered. HMRC expects to see an analysis in support of any valuation used.
If you have any questions about the treatment of awards of a carried interest or the reporting requirements, please contact Stephen Kenny.
