IFM40225 - Eligibility criteria: ownership condition: FA22/SCH2/PARAS 5 to 7

PARA 5 contains various computational provisions relating to the determination of relevant interests. Following the general modelling of these provisions on the group relief rules (see IFM40210) many of these are imported from those rules with necessary adjustments. There are, however, two new rules specific to the ownership condition.

The first rule deals with ‘investment management profit-sharing arrangements’. This addresses the position of asset managers with carried interest style entitlements. Such entitlements will vary in amount depending on the overall performance of assets under management and can be entered into by individuals performing investment management services (investment managers) or the asset management business itself. This variation can lead to asset managers – who will almost inevitably not be category A investors – being entitled to very significant proportions of profits in periods where their carried interest entitlement ‘catches up’ from a low percentage of the whole to a higher one. The rule disregards any such variations and instead requires that persons with entitlements under investment management profit sharing arrangements are to be assumed to be entitled to their maximum total percentage entitlement that could arise over the life of the arrangements at all times. Note that the relevant interests of all parties concerned should be computed on the basis of this rule, not just the interests of those participating in the investment management profit-sharing arrangements. So, if there is a group of investment managers with a maximum carried interest entitlement of 20 percent, all other parties with relevant interests should be taken to have proportionate shares of the remaining 80 percent.

The second rule excludes from consideration dividend entitlements which amount to fees for administrative services provided in connection with investment in the relevant company. This prevents companies failing the ownership condition where, for example, a commercial trustee takes remuneration for its role in holding securities in a company in the form of a dividend rather than a fee.

Additionally, when considering relevant interests held through transparent entities, PARA 6(5) provides that priority profit share arrangements should be disregarded. A common example of such arrangements is where the general partner of a limited partnership fund has priority entitlement to income or gains to satisfy reimbursement of management fees paid on behalf of the partnership.

Generally, where securities giving rise to relevant interests are held by partnerships or by trustees of bare trusts, those arrangements will be disregarded and participants in them will be treated as holding interests in the underlying companies directly in accordance with the normal rules of ‘tax transparency’. In such cases, voting rights are deemed by PARA 6(6) to accrue to the participants and not to the partnership or trustee.

The exception to this rule is where the partnership or trust is a ‘transparent qualifying fund’. The rules effectively treat such arrangements as persons in their own right when considering the ownership condition. This is necessary as otherwise, for example, any such fund comprised exclusively or in significant part of retail investors would not qualify as a category A investor. PARA 6(2)(b) and 6(3) provide for this, save in the limited case where the anti-fragmentation rule in PARA 4(1)(b) is in point.

The anti-fragmentation rule in PARA 4(1)(b) needs to be read in conjunction with PARA 6(2)(a) where part of the fragmented interest is held through a transparent qualifying fund. The effect of PARA 6(2)(a) is to disapply the normal rule in PARA 6(2)(b) that any interest arising to a person via participation in a transparent qualifying fund are deemed to arise to the fund. Instead, where a person has a beneficial entitlement to profits or assets of a potential QAHC arising partly directly or via a connected company and partly via the fund, the entitlement held via the fund is treated as an entitlement held through another person within PARA 4(1)(b)(ii).

PARA 7 clarifies that when considering the extent of voting power, the rules look to the default position in relation to voting in a forum of members, such as an annual general meeting, on a resolution for which there are no specific rules in relation to the voting power of members. Disproportionate voting rights in relation to particular kinds of business are ignored.