Non-residents trading in the UK: through UK investment managers, brokers or Lloyd’s agents: investment managers: the 20% rule
When the 20% rule is satisfied
The “20% rule” (in ITA07/S835M and CTA10/S1146) is satisfied where the investment manager and any connected persons (as defined at CTA10/S1122 for corporation tax and ITA07/S993 and S994 for income tax) are not beneficially entitled to more than 20% of the taxable profits of the non-resident from transactions carried out through the investment manager. Where the 20% limit is exceeded in respect of one non-resident participating in a managed fund the exemption cannot apply in respect of the investment manager’s transactions on behalf of that non-resident. The test is then applied separately to any other non-resident participators in the fund.
The 20% rule is tested over a ‘qualifying period’. This could be:
- the accounting period in which the transaction in question is carried out, or
- a period of not more than five years comprising two or more complete accounting periods including the one in which the transaction in question is carried out (see example at INTM269120).
If there is a failure to meet the 20% limit but it was the intention of the investment manager and persons connected with him that this limit would be met during the qualifying period, the rule will be treated as met where:
- the failure is attributable to matters outside the control of the investment manager and persons connected with him, and
- the failure does not result from a failure by him or any of those connected persons to take reasonable steps to put it right.
Performance related fees do not normally affect the operation of the 20% rule, as the rule looks at the beneficial interest in the taxable profits of the non-resident from trading through the investment manager. The investment manager’s fees, including performance related fees, are normally allowable as a deduction in arriving at those profits, and are thus netted off before applying the 20% rule. Consider critically whether the fees, however described or justified, are of the nature and amount that an independent investment manager would receive for similar business.
HMRC recognise that incentive allocations are performance fees in substance. As such, they are income in nature and where they are recognised by the UK manager as fee income, the allocations may be treated as fees payable by the non-resident when computing the chargeable profit.
Options granted to investment managers to acquire securities or interests in the non-resident, within the meanings at ITEPA03/S420, need only be considered in the context of the 20% test when the options are exercised. They should be brought into charge at full market value for the customary remuneration test (see INTM269175).
Where a structured product is issued to customers which provides a return based on the performance of the non-resident, entitlement to the income of the non-resident remains with the investor in the non-resident (likely to be the product issuer) and not with the holder of the structured product for the purpose of the 20% test.