IFM36430 - Co-investment: Acquired co-investments

Acquired Co-investments

ITA07/S809EZB(1)(b)

Investments in funds are not always financed by a personal contribution from the fund manager. In some situations a fund manager may acquire their co-investment from another person instead. For example, this could happen where a fund manager may join a pre-existing team, or where an entire team managing a fund changes (for example, because of poor performance or due to a wider business takeover).

Where the co-investment has been acquired in circumstances other than personal contribution, HMRC’s view is that the repayment of and return on that investment may still come within the exclusions of the definition of “management fee” in ITA07/S809EZB(1).

Acquired co-investments and the arm’s length condition

One of the exclusions referred to above is the arm’s length condition (IFM36420).  HMRC’s view is that this exclusion might apply to acquired co-investments, in the same way as it does to those financed by personal contribution.

It is perhaps more difficult to establish whether the sums returned are at arm’s length where the co-investment has been acquired other than by personal contribution. This is because the value of the co-investment is likely to have moved since the original investment was drawn down from the person now selling their interest in the fund. If the fund has performed poorly the co-investment may be worth less than the vendor originally contributed, and vice versa. 

• Where investment in the fund has fallen in value: when the fund manager purchases the investment for an amount equal to its market value, the fund manager will receive a return that exceeds that paid to external investors whose return will still be calculated on the original amount they contributed to the fund. Therefore the arm’s length test is not met.

Here, to meet the arm’s length condition, it is necessary for the fund manager to pay at least the “par value” of the co-investment. This is the case even if the par value exceeds the market value of the investment.

• Where investment in the fund has increased in value: when the fund manager purchases the investment for the amount originally contributed to the fund, they will receive a return that exceeds the amount paid to external investors. Therefore the arm’s length test is not met.

For the entire sum to meet the arm’s length test, the fund manager will need to pay a price which equals the increase in value of the investment in the fund.

In contrast the full unrestricted market value may have been paid at the point of acquisition as part of a genuine commercial arrangement negotiated at arm’s length. In that case HMRC would generally accept that the return is capable of being excluded from the disguised investment management fees (DIMF) charge, provided all the arm’s length conditions of ITA07/S809EZB(2) are met

Investment schemes constituted as limited companies

In the context of investment schemes constituted as a limited company, ITA07/S809EZE(3) makes specific reference to secondary acquisitions (purchasing pre-existing investor commitments). This should not be read as restricting the meaning of ITA07/S809EZE(2) which applies more generally in determining what amounts to an investment in an investment scheme.

The wording “whether by way of capital, loan or otherwise” (emphasis added) shows that ITA07/S809EZE(2) is not to be read in an overly narrow manner. By acquiring a person’s interest in the scheme it is therefore possible to “step into their shoes” in respect of the contribution to the property held by the scheme.

ITA07/S809EZE(3) puts beyond doubt that in the situation where the investment scheme is constituted as a limited company (which will be the beneficial owner of the underlying assets and where investors acquire shares in that company) the same treatment is available as regards acquired co-investments. It is designed to make sure that the same rules apply regardless of how a scheme is constituted, rather than applying specifically relaxed rules to corporate schemes over other types of investment vehicle.