IFM37730 - Accruals basis elections: operation of charge

TCGA92/S103KFA

Once a valid election has made, then immediately before the end each tax year a chargeable gain may be deemed to arise to the individual. Any deemed chargeable gain is subject to capital gains tax at the rate which applies to carried interest taxed under the general rules (IFM37130).

The deemed chargeable gain is calculated on the basis set out in legislation at TCGA92/S103KFA(4) and (5).

Broadly, the calculation seeks to determine the carried interest that would arise to the individual if the investment scheme disposed of all assets then held or previously held by it at the end of the relevant tax year and then reduces that amount by the sum of all chargeable gains deemed to have arisen to that individual in respect of the relevant scheme in previous tax years.

The calculation methodology is as follows:

1. Take the sum of the following:

  • Proceeds received by the investment scheme in the relevant tax year on the disposal of any investments which are relevant to the individual’s entitlement to carried interest.

An investment will be relevant to the individual’s entitlement to carried interest for these purposes if the amount realised on the disposal of the investment has an impact (positive or negative) on the amount of carried interest which will arise to the individual.

  • Income received by the investment scheme in the relevant tax year from investments which are relevant to the individual’s entitlement to carried interest.
  • Proceeds received by the investment scheme in previous tax years on the disposal of any investments which are relevant to the individual’s entitlement to carried interest.
  • Income received by the investment scheme in previous tax years from investments which are relevant to the individual’s entitlement to carried interest.
  • The proceeds which would be received if all remaining investments held by the investment scheme were disposed of at an amount equal to cost incurred by the investment scheme in acquiring the investment.

2. Determine the amount of carried interest which would arise to the individual if the sum of 1. above had arisen to the investment scheme in the relevant tax year and had been distributed to the investors. The general rule is that for the purposes of this step, it is assumed that any profits which have been distributed to investors (including other individuals) in previous tax years are instead distributed in the relevant tax year. However, where the timing of distributions made to external investors is relevant in determining an individual’s entitlement to carried interest (for example, where it is relevant to the calculation of an applicable ‘preferred return’ or ‘hurdle’), for those purposes distributions made in previous tax years are to be assumed to have been made at the time they were actually made.

3. Deduct from the amount produced by 2. above any chargeable gain which has been deemed to arise to the individual under TCGA92/S103KFA in previous tax years.

The amount produced by this calculation is the individual’s deemed chargeable gain for the relevant tax year under TCGA92/S103KFA. The amount may be nil in a tax year where no investments have been disposed of and no income has arisen.

Note that although some sums which form part of the above calculation may be income in nature (for example interest or dividend income received by the investment scheme), TCGA92/S103KFA can only operate to create a deemed chargeable gain. An individual will only be taxed on income if and when such income actually arises to them from the investment scheme.

The income based carried interest rules contained in ITA07/S809FZA-Z will not apply as part of the TCGA92/S103KFA calculation.

Under TCGA92/103KFA(8), where an individual performs relevant investment management services outside the UK, the deemed chargeable gain will be classed as a foreign chargeable gain to the extent that the individual performs investment management services outside the UK. This is irrespective of the location of the investment scheme assets and mirrors the provision in TCGA92/S103KC.

See IFM37300 for more information on carried interest which is a foreign chargeable gain.