IFM36325 - Disguised fees: Condition 3 - The sum arising must be untaxed

Condition 3 - The sum arising must be untaxed

ITA07/S809EZA(3)(d)

ITA07/S809EZA(4)

The third condition for the sum to be a disguised fee is that some or all of that sum must be untaxed.

Is the management fee untaxed?

The term “untaxed” is expanded in ITA07/S809EZA(4). Any sum is untaxed where it is not:

• charged to tax as employment income on the individual (ITA07/S809EZA(4)(a)); or
• brought into account in calculating the profits of a trade for income tax purposes for any tax year, whether carried out individually or in partnership (ITA07/S809EZA(4)(b)).

Therefore, if a management fee is already charged to trading income from a sole trade or partnership or as income from employment there will be no additional charge under the DIMF rules.

Example 1 - accountancy partnership

Ali is a partner in CD LLP, a large accountancy firm. Ali carries out due diligence on a potential acquisition by RS LP, an unconnected private equity fund. CD LLP received a fee from the fund for doing so and this increases CD LLP’s profits. Ali receives a share of those profits.

Due diligence falls within (b) of the “investment management services” definition found at ITA07/S809EZE(1).

The fee is included in the profits of CD LLP, ITA07/S809EZA(4)(b) advises that a sum will not be considered as ‘untaxed’ if it has been brought into account in calculating the profits of an individual and, as Ali has received a share of those profits, which will be chargeable to income tax, the sum will not be considered as ‘untaxed’ in her hands.

If a sum arises to someone other than the individual that provides the investment management services there are further provisions to consider, ITA07/S809EZDA and ITA07/S809EZDB ITA 2007.

Benefits of any kind that are considered, and are as a consequence, relieved or exempted within ITEPA 2003 are not considered to be untaxed income.

Sums taxed in different periods

A fee is not untaxed if it has been subject to tax in a different year to the charge that would otherwise arise under the DIMF rules.

Example - deferred bonus

Chris performs investment management services and is engaged as an employee.  He receives a deferred bonus which does not fall within the definition of carried interest. Chris agrees with his employer that the bonus payment can be deferred until the following tax year.

It has been decided that the bonus arises to Chris at the date the bonus is paid. At the point that the ‘deferred bonus’ is granted it will be charged to income tax and national insurance contributions in full as employment income.  It will therefore not be an ‘untaxed’ management fee in the tax year that it is paid as it has been taxed as employment income in the previous tax year.

If it were the case that the individual expected to be outside the charge to UK tax when the sum would otherwise be liable to income tax, the deferred sum will be ‘untaxed’ as it has not been charged to tax as employment income or brought into account in calculating the profits of a trade for the purposes of income tax.

Management fees that are part taxed

If a management fee is only part taxed, condition 3 is met in relation to the untaxed part, and the other two conditions should be considered in respect of the untaxed part of the fee to consider if it is in part a disguised fee.