The Taxman Cometh Jon Brose (Seward & Kissel) Martin Shah Hatice Ismail Zoë Arnautov Wednesday 11 & Thursday 12 October 2017
Session agenda A time of change in the tax environment What do asset managers need to be aware of? Continuing evolution of UK partnership taxation relevant to managers and funds Renewed investor demand for UK reporting fund status U.S. Tax Update Tax Reform Upcoming Partnership Audit Regime Other Recent Developments 1 / L_LIVE_EMEA1:37627171v1
UK partnership taxation a moveable feast 2 / B_LIVE_EMEA1:2816984v1
UK partnership rules a brief history 2013 2014 2015 2016 2017 Compensating adjustments Salaried members Mixed membership partnerships Disguised investment management fees (Parts I & II) Income-based carried interest rules Consultation on further changes 3 / L_LIVE_EMEA1:37627171v1
Changes to UK profit allocation rules No more streaming Allocation of partnership trading profits for tax purposes will now follow pro rata allocation for accounting purposes removing ability to stream e.g. expenses disallowed for tax purposes to a corporate member with a lower effective tax rate Implications unclear where profit sharing arrangements have a discretionary element and discretion is exercised post period end Does not appear to affect allocations of amounts derived from investments outside the trade(s) of the partnership Allocation of profit shown on partnership tax return is definitive with respect to UK tax treatment of partners; new mechanism for reference to tribunal of disputes between partners and partnership over proportion of profit allocated to partner (as opposed to computation of overall partnership profits) 4 / L_LIVE_EMEA1:37627171v1
Changes to UK profit allocation rules - before Item A/c profits Tax profits Cash tax Net cash Effective tax rate Income 500 500 Expenses allowable (250) (250) disallowable (50) - Net profit 200 250 Allocation A 100 100 (47) 53 47% Allocation - Ltd 100 150 (28.5) 71.5 28.5% 5 / L_LIVE_EMEA1:37627171v1
Changes to UK profit allocation rules - after Item A/c profits Tax profits Cash tax Net cash Effective tax rate Income 500 500 Expenses allowable (250) (250) disallowable (50) - Net profit 200 250 Allocation A 100 125 (58.75) 41.25 58.75% Allocation - Ltd 100 125 (23.75) 76.25 23.75% 6 / L_LIVE_EMEA1:37627171v1
UK partnerships additional points Chains of partnerships Relaxed compliance for investment partnerships reporting under CRS Bare nominee/trust arrangements Indirect partners 7 / L_LIVE_EMEA1:37627171v1
Other HMRC hotspots Salaried member rules Mixed membership partnerships use of corporate member to retain profits Incentivisation arrangements Disguised investment management fees 8 / L_LIVE_EMEA1:37627171v1
Reporting funds redux 9 / B_LIVE_EMEA1:2816984v1
Remind me what a reporting fund is? Not taxing gains at income tax rates Since 2009 many more non-uk funds are within the UK definition of an offshore fund Default position is that gains realised by a UK resident individual investor on a disposal of offshore fund interests are offshore income gains subject to income tax at rates of up to 45% rather than capital gains taxed at up to 20% Investment manager can apply for funds / classes of shares to be recognised as a reporting fund in which event disposal gains may be subject to capital gains tax, subject to conditions Quid pro quo is that any reportable income is taxable as income during lifetime of investment, whether or not distributed Not as relevant to UK resident but non-domiciled investors taxed on the remittance basis as this group can leave disposal gains offshore and outside UK tax net 10 / L_LIVE_EMEA1:37627171v1
Changes to UK domicile rules Advent of deemed domicile makes reporting funds attractive to a new group Finance Bill 2017-2019 (due to become Finance (No.2) Act 2017 before the end of the year) introduces the concept of deemed domicile with effect from 06 April 2017 Non-UK domiciled individuals will be deemed domiciled in the UK for tax purposes where they have been UK resident for 15 of the past 20 tax years Individuals born in the UK with a UK domicile of origin, but who have acquired a domicile of choice elsewhere, will now be deemed UK domiciled for all tax purposes at any time while they are UK resident Individuals who became deemed domiciled in April 2017 (excepting those who were born in the UK with a UK domicile of origin) will automatically have all their assets, including interests in offshore funds and other non- UK based assets, rebased to their market value on 05 April 2017 Rebasing has the effect of partially exempting any eventual gain (the portion accrued to 05 April 2017) in respect of future gains reporting fund status likely to be attractive 11 / L_LIVE_EMEA1:37627171v1
Reporting funds - practicalities Watch out for existing investors Reporting fund status must be applied for by the end of the first accounting period for which it is desired For investors to get benefit, offshore fund interests must have reporting fund status throughout the period of the investor s ownership acquiring status post acquisition will just attract ongoing income tax charges without eventual beneficial gains treatment Solution is election for deemed disposal and reacquisition suitable for new deemed domiciled investors in conjunction with April 2017 rebasing of offshore fund interests 12 / L_LIVE_EMEA1:37627171v1
US Tax Update - Tax reform - Partnership audit changes - Other recent developments 13 / B_LIVE_EMEA1:2816984v1
US Tax Reform Goals of US Tax Reform Make the tax code simple, fair and easy to understand. simplify filings. provide greater fairness for all by closing special interest tax breaks and loopholes. Lower taxes for working Americans. Tax relief for middle income families. Attract jobs by leveling the playing field for American business and workers. tax relief for businesses, especially small businesses. Repatriate offshore earnings to reinvest in the economy. 14 / L_LIVE_EMEA1:37627171v1
US Tax Reform International Tax Proposals Shift to territorial tax system. Full exemption for dividends from non-us subsidiaries in which the US corporate taxpayer owns at least 10%. Repatriation of non-us earnings during transition period. Transitional rule will treat accumulated foreign earnings as repatriated and subject to US taxation. Lower rate for illiquid assets versus cash and cash equivalents. - Many details left to Congress. - Unclear how financial services will be affected. - Unlikely to see major changes to PFIC/CFC regimes. Rules will be written to prevent profit shifting to tax havens by US multinationals. 15 / L_LIVE_EMEA1:37627171v1
US Tax Reform Business Income Tax Proposals Targeted corporate income tax rate of 20%. Aims to eliminate the corporate alternative minimum tax. Maximum tax rate of 25% for business income conducted through sole-proprietorships, partnerships and S corporations. Trump intent on ending carried interest loophole. Partially limited deductibility of net interest expense incurred by C corporations. Likely carve out for financial services. Businesses may immediately write off ( expense ) new investments in depreciable property, other than structures. 16 / L_LIVE_EMEA1:37627171v1 Key Insights: - Morgan Stanley expects 15% earnings lift with 25% rate. - Citigroup expects $800m additional net income from 25% rate and tax holiday on repatriation. - Citigroup may have to reduce value of deferred tax assets by $15b with a 20% rate. - BoA has $7b of DTAs subject to revaluation. - Interest deductibility may impact debt issuances. Source: Demos, et al., Wall Street Journal, Proposal Expected to Benefit Wall Street (Sept. 27, 2017)
US Tax Reform Individual Income and Estate Tax Proposals Consolidate seven tax brackets to three: 12%, 25% and 35%. Congress can approve a higher tax bracket on high income earners. Repeal the Alternative Minimum Tax. Larger deductions and credits creates an effective zero tax bracket and will simplify tax filings for many middleincome families. Repeals the estate tax but leaves door open for capital gains taxation at death. 17 / L_LIVE_EMEA1:37627171v1
Upcoming Centralized Partnership Audit Regime New Rules The Big Picture The Bipartisan Budget Act of 2015 (the Budget Act) establishes new rules for partnership audits and assessment of tax (the New Rules ). Repeals TEFRA and Electing Large Partnership rules. Changes the way partnerships are assessed tax, and, for the first time, makes a partnership liable for federal income tax. - Require changes to new and existing LPAs. - Should be considered in connection with due diligence. Generally effective for partnership returns filed for tax years beginning after December 31, 2017. Proposed Regulations were issued June 2017. 18 / L_LIVE_EMEA1:37627171v1
Upcoming Centralized Partnership Audit Regime New Role: Partnership Representative Tax Matters Partner (TMP) eliminated. Partnership Representative - Partnership must designate a partner or other person with a substantial US presence as the Partnership Representative to have sole authority to act on behalf of the partnership. Designation occurs on annual partnership return. If no designation, Secretary may select any person. - Challenges for non-us partnerships: - Natural person with a substantial US presence Partnership and all partners bound by the actions and decisions of the Partnership Representative. 19 / L_LIVE_EMEA1:37627171v1
General Overview of the New Rules Election Out of New Rules General non-tefra rules that were not modified by Budget Act apply BUT, must meet certain eligibility requirements 100 qualified partners Not available for partnerships which have a DREs, trust or partnership as a partner Election made each year on a timely filed return General Rule Partnership Pays Partnership taxed at highest applicable rate in current year Current partners bear economic burden Consider possibility of reducing imputed underpayment amount (which, in some cases, may require past year partners to file amended returns) Adjustments resulting in overpayments taken into account by partnership in adjustment year as change in non-separately stated income or loss (or as separately-stated credit) Interest and penalties determined at partnership level Alternative Rule for Underpayments Partnership Pushes" Reviewed year partners increase chapter 1 taxes in current year based on as if amended formula for the reviewed year through the current year Partners pay interest at increased rate and penalties Alternative rule does not apply to overpayments 20 / L_LIVE_EMEA1:37627171v1 Page 20
Other Recent Developments Delayed phase in of 871(m) Rules No withholding obligation on non-delta-one transactions until 2019. Short parties can continue to apply simplified standard for identifying combined transactions. SPs entitled to presumption that multiple transactions should not be combined where such transactions are entered into more than 2 days apart or held in separate accounts, unless actual knowledge that transactions should be combined. No withholding on dividend-equivalents to Qualified Derivatives Dealers. Section 385 Pursuant to executive order, Treasury intends to replace the documentation rules under Section 385 with streamlined rules. Distribution rules retained, pending tax reform. 21 / L_LIVE_EMEA1:37627171v1
Other Recent Developments Tax Court Decision in Grecian Magnesite Mining Non-US partner redeems its interest in a partnership that held FIRPTA assets and was also engaged in a US trade or business. Non-FIRPTA gain on redemption of partnership interest was capital gain, not ECI. Tax Court treated the partnership interests as a sale of a capital asset, rejecting IRS's aggregate theory for treating redemption as sale of separate interests in each asset owned by the partnership. 22 / L_LIVE_EMEA1:37627171v1
New corporate criminal offences 23 / L_LIVE_EMEA1:37627171v1
Corporate Criminal Offences of Failure to Prevent the Facilitation of Tax Evasion Criminal Finances Act 2017 came into force on 30 September 2017 01 September 2017 - final HMRC guidance published Ongoing - finalisation of industry specific guidance with HMRC Penalties Criminal penalties not personal liability Unlimited financial penalties and disgorgement of profits Impact on regulated businesses Two types of offence: Failure to prevent the facilitation of the evasion of UK tax Failure to prevent the facilitation of the evasion of foreign tax Defence: had reasonable prevention procedures in place (or not reasonable in all the circumstances to have any prevention procedures in place) 24 / L_LIVE_EMEA1:37627171v1
Facilitation of Tax Evasion Offences Facilitation of UK tax evasion offence A relevant body (B) is guilty of an offence if a person commits a UK tax evasion facilitation offence when acting in the capacity of a person associated with B. Facilitation of foreign tax evasion offence (1) A relevant body (B) is guilty of an offence if at any time - (a) a person commits a foreign tax evasion facilitation offence when acting in the capacity of a person associated with B; and (b) there is a UK nexus. (2) There is a UK nexus if - (a) B is a body incorporated, or a partnership formed, under the law of any part of the United Kingdom; OR (b) B carries on business or part of a business in the United Kingdom; OR (c) any conduct constituting part of the foreign tax evasion facilitation offence takes place in the United Kingdom. Associated person An employee, agent or a person performing services for or on behalf of the entity whilst acting in that capacity 25 / L_LIVE_EMEA1:37627171v1
The Defence Prevention procedures means procedures designed to prevent persons acting in the capacity of a person associated with B from committing UK tax evasion facilitation offences What are reasonable procedures?: Proportionate procedures Top-level commitment Risk assessment Due diligence Communication Monitoring & Review Irrespective of the size of the business the risk assessment is crucial and should be carried out as a minimum requirement Risk assessment should identify and prioritise the risk across the organisation, be performed periodically and be documented 26 / L_LIVE_EMEA1:37627171v1
Compliance steps What should your business have done by day 1? Initial risk assessment performed across the business Top-level commitment Initial communication from top-level management made (or at least planned) Implementation plan for tackling the risk in a proportionate and timely manner What next? Generally plug specific gaps identified by risk assessment Update/adopt new policies and procedures Train all relevant staff Review/update contractual Ts & Cs, including contracts with agents and service providers (where reasonable and proportionate) Amend other documents e.g. client/investor marketing, on-boarding documents, Ts & Cs 27 / L_LIVE_EMEA1:37627171v1 Conduct regular review
Contact details Jon Brose Partner (Seward & Kissel) Tax T +1 212 574 1615 E brose@sewkis.com Hatice Ismail Partner Corporate Tax T +44 20 7825 3977 E hatice.ismail@simmons-simmons.com Martin Shah Partner Corporate Tax T +44 20 7825 4638 E martin.shah@simmons-simmons.com Zoë Arnautov Managing Associate Corporate Tax T +44 20 7825 3091 E zoe.arnautov@simmons-simmons.com 28 / L_LIVE_EMEA1:37627171v1
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