IFM36120 - Overview: Introduction

Introduction

A high level explanation of the disguised investment management fees (DIMF) rules

The disguised investment management fees (DIMF) rules apply to certain sums paid to investment managers. The rules detail how in some circumstances these sums will be charged to income tax.

Many investment management businesses only charge a management fee for the services they provide. However, those who provide services to private equity funds and other funds with alternative strategies typically negotiate:

  • a ‘management fee’ based on funds (or assets) under management generally at a rate of 1.5-2%; and
  • a share of the funds’ profits once the investments have grown by an agreed percentage (hurdle) which is commonly referred to as ‘carried interest’ (IFM36500).

In a typical model, management fees are due irrespective of how well an investment fund performs. They can be paid monthly, quarterly or annually. Carried interest is only paid when the fund performs to a pre-agreed standard. It is performance-related payment typically paid indirectly, through a special purpose vehicle to the individuals who provided investment management services to a fund. Meeting the ‘hurdle’ (or ‘preferred return’) typically means that those involved in managing the fund share 20% profits above a hurdle rate equivalent to an annualised rate of approximately 8%. These amounts vary depending on the agreement entered into with the investors.

Other funds that are not partnerships may agree to pay a performance fee in addition to a management fee. These sums should also be considered under the DIMF rules.

The tax treatment of an investment management fee is covered by the DIMF rules. The main aim of these rules is to ensure that management fees received for managing an investment scheme (and which are not calculated by reference to the performance of the underlying investments) are charged to income tax where they arise to individuals. This is because the amounts in question are in substance income paid in return for the provision of investment management services.

Broadly, the DIMF rules ensure that where sums arise from a fund to an individual providing investment management services, those sums are charged to income tax where they are not:

  • carried interest; or
  • a return of capital; or
  • a return on sums invested

The tax treatment of the first management fee described above (generally 1.5-2% of funds under management), as detailed throughout this guidance applies to any fund which is an investment scheme (IFM36230) irrespective of its structure.

New rules for the tax treatment of carried interest took effect from 8 July 2015. Carried interest is subject to taxation under specific capital gains tax (CGT) rules which are covered in separate guidance, starting at IFM37100. Carried interest is defined in ITA07/S809EZC, which is in Chapter 5E, and sums meeting this definition are excluded from DIMF rules unless the amounts are Income Based Carried Interest (IBCI).  Income Based Carried Interest is explained in detail in separate guidance, starting at IFM38000. (reference currently not active - manual awaiting completion) 

Prior to the introduction of the DIMF rules, carried interest was not defined in the Taxes Acts. However it was explained in a 2003 Memorandum of Understanding agreed between the British Venture Capital Association (BVCA) and the Inland Revenue (a predecessor department to HM Revenue & Customs) (IFM36540).