The long-awaited first Autumn Budget since Labour won the General Election in July has introduced significant changes that will impact the private equity industry. Tax rises amounting to £40bn were announced together with spending cuts and changes to the definition of debt to allow for investment in infrastructure projects.
CGT
As predicted, a key area of focus has been capital taxes. Capital gains tax for share disposals has increased for both basic and higher rate taxpayers (basic rate increased from 10% to 18% and higher rate taxpayers 20% to 24%). Both changes are effective from Budget Day (30 October 2024). Business Asset Disposal Relief has been maintained at the current lifetime level of £1m but the tax rate applicable will increase from 10% to 14% from 6 April 2025 and then to 18% from 6 April 2026.
The Chancellor has confirmed there will be a two-step reform of the taxation of carried interest. The first step involves raising capital gains tax rates on carried interest to 32% for both basic and higher rate taxpayers, effective from 6 April 2025. The second stage, expected to take effect after April 2026, will remove capital gains treatment for carried interest, which will then be taxed within the income tax framework. A 72.5% multiplier will be applied to ‘qualifying’ carried interest brought within charge. Details on the mechanics of this ‘multiplier’ as well as what constitutes ‘qualifying’ carried interest are still to be clarified.
Non-UK domicile regime
It has been confirmed that the current non-UK domicile tax regime will be abolished from 6 April 2025 and replaced with a residence based regime.
Employment taxes
Several changes were also announced that will impact portfolio companies including an increase in employers’ national insurance contributions from 13.8% to 15% (effective from 6 April 2025) and a lowering of the threshold at which this applies. The employment allowance, which can reduce the employers’ national insurance costs, has been increased to £10,500 in total and the £100,000 qualifying limit removed. Employment costs may also be impacted by increases to the national living wage (for employees over 21) from £11.44 to £12.21 and national minimum wage (for employees agreed 18 to 20) from £8.60 to £10.
Corporate tax road map
The Government published its corporate tax road map setting out a key theme of stability and areas for consultation. No significant changes have been announced other than confirmation that the headline corporation tax rate will not rise above 25% and that generous reliefs for Research and Development and capital expenditure will remain. A consultation is also taking place on transfer pricing.
The impact of these increases to spending, borrowing and taxation will be closely monitored by the Bank of England’s monetary policy committee as it sets interest rates.
The Chancellor has said she hopes the £40bn of tax rises will be a one off. A significant proportion of these rises has fallen on the shoulders of employers, and it is hoped this will not adversely impact growth or job creation.
Rises in capital gains and inheritance taxes create a further challenge to private equity investors and entrepreneurs but the changes announced are not quite as significant as some of the initial speculation.
As ever, it is important to obtain proactive tax advice as early as possible to understand the specific implications of the Budget and how this will affect you.
The Chancellor has announced that there will be an immediate increase to the rates of capital gains tax (CGT) with the basic rate rising to 18% and the higher rate to 24%.
There will also be a staggered increase to the CGT rates for business asset disposal relief (BADR) and investors’ relief (IR), with effect from 6 April 2025.
The main rates of CGT have been increased for all disposals made on or after 30 October 2024. The tax rates will increase from 10% to 18% at the basic rate and from 20% to 24% at the higher rate. CGT rates applying to disposals of residential property will remain unchanged and are now aligned with the main rates of CGT.
No changes have been made to the annual exempt amount and taxpayers will still be able to claim relief for capital losses and choose to offset these against capital gains in the most tax efficient way.
BADR and IR have also been amended. The rate of CGT on disposals of assets eligible for BADR or IR will increase from 10% to 14% from 6 April 2025, with a further increase to 18% from 6 April 2026.
The lifetime limit for IR has been reduced from £10 million to £1 million for disposals made on or after 30 October 2024. The lifetime limit for BADR remains unchanged at £1 million.
An increase to the rate of CGT was widely expected, however there was little consensus as to what the exact rate would be or from when the changes would take effect. With the immediate changes to tax rates, 2024/25 will be a tax year of multiple CGT rates.
The increase in rates to 18% and 24% aligns the main rates of CGT with the rates for residential property disposals, which should reduce one element of complexity in the system for taxpayers.
Taxpayers should look to ensure that any available losses are utilised in the most tax efficient manner.
The Chancellor has announced that the current remittance basis regime for non-UK domiciled individuals will be replaced with a residence-based regime from 6 April 2025.
Under current law, a non-UK domiciled individual (broadly someone originating from outside the UK who does not intend to remain in the UK permanently) can elect to be taxed in the UK on the ‘remittance basis’, until they have been resident in the UK for 15 out of the past 20 tax years. Individuals who use the remittance basis are only taxed on non-UK income and gains that are brought to, received or used in the UK. The Government will replace this regime with one based on tax residence from 6 April 2025.
Under the new foreign income and gains regime (FIG regime), qualifying individuals will not pay tax on foreign income and gains for the first four years of UK tax residence provided they have not been UK tax resident in the ten tax years prior to their arrival, irrespective of domicile status. Taxpayers who choose to use the FIG regime will not be entitled to an income tax personal allowance or capital gains tax (CGT) annual exemption for the relevant tax year.
The following transitional arrangements will be available to existing non-UK domiciled individuals after 6 April 2025:
From 6 April 2025, the protection from tax on foreign income and on capital gains arising within settlor-interested trusts will no longer be available. This means that the income and gains will be taxable on the settlor unless the settlor qualifies for and claims the FIG regime. There have also been updates to rules around matching trust income and gains to distributions to beneficiaries who claim the FIG regime and to rules on onward gifts and distributions to close family members of the settlor.
Overseas workday relief rules will also be revised from 6 April 2025. Under existing rules, inbound non-UK domiciled employees can benefit from an income tax exemption on income from non-UK duties for the first three years of UK residence, subject to that income not being remitted to the UK. The new rules will extend the relief to the first four years of UK residence, whilst removing the requirement to keep the income offshore. This means that the overseas element of the employment income can be brought to the UK without a tax charge. This is subject to a limit of the lower of £300,000 and 30% of an individual’s total employment income.
A new residence-based regime will be introduced for inheritance tax (IHT). There will be a ten year exemption from IHT on non-UK assets for new ‘arrivers’ and a ‘tail-provision’ to keep a taxpayer within the scope of UK IHT on worldwide assets for a period after leaving the UK. The length of the period covered by the tail provision will depend on how long the individual was UK resident for before they left. Individuals who are within the scope of UK IHT on worldwide assets will be referred to as ‘long-term residents’.
In most cases, the IHT status of assets held in trusts will depend on the long-term residence status of the settlor at the time of the chargeable event. This means that assets held in trusts might move in and out of the scope of UK IHT depending on the status of the settlor at the relevant time. These rules will apply to all trusts regardless of whether they were created before or after 6 April 2025 and regardless of the domicile, or deemed-domicile status, of the settlor at the time of the settlement. The only exception to this rule is where a settlor has died before 6 April 2025. In such cases, non-UK assets held in the trust will continue to be excluded property for IHT purposes if the settlor was neither UK domiciled nor deemed-UK domiciled when the settlement was made.
The previous Conservative Government had already announced some of these changes, so it was well anticipated that the Labour Government would replace the non-UK domicile regime.
The Government will hope that the new rules can still attract individuals to the UK. New arrivers will not be taxed on funds that they bring to the UK, whereas existing rules charge tax on remittances of foreign income and gains that arise after an individual becomes UK resident. Longer term UK residents stand to lose out, particularly if they had anticipated using the remittance basis beyond 5 April 2025 or if they benefit from either of the existing protected trust and excluded property regimes for offshore trusts.
Individuals becoming taxed on a worldwide basis may need to give greater consideration to international tax treaties.
The IHT and trust, in particular the IHT ‘tail’ provisions, are likely to be of significant concern to non-UK domiciled individuals and the trust changes are likely to significantly increase compliance burdens.
There is now a window of just a few months, during which time affected taxpayers should take the opportunity to review their tax affairs and plan for how the new tax regime will affect them in the future.
With effect from 6 April 2025, the headline rate of employers’ national insurance contributions (NIC) will be increased by 1.2% to 15%.
The secondary threshold will be reduced from £9,100 to £5,000 per employee and the employment allowance will be increased from £5,000 to £10,500 for eligible employers.
The Chancellor has announced that the headline rate of employers’ NIC will be increased from 13.8% to 15%. The same increase will also apply to Class 1A and Class 1B NIC rates that employers pay on the provision of taxable benefits to employees.
In parallel, the Government will reduce the secondary threshold (the earnings above which employers begin paying employers’ NIC on an employee’s earnings), from £9,100 per employee per year to £5,000 per employee per year.
The Chancellor also announced changes to the employment allowance, which can be used to reduce an employer’s NIC bill. The allowance will be increased from £5,000 to £10,500 per year and, in a move to simplify the system, the existing £100,000 eligibility threshold will be removed, This threshold restricted eligibility for the employment allowance to employers with a total employers’ NIC liability of less than £100,000.
All of the above changes take effect from 6 April 2025.
The Government has estimated that these changes will raise approximately £24 billion per annum over the next five tax years.
While the increase in employment allowance softens the impact for small employers, the employers’ NIC changes are likely to represent a significant additional cost for larger employers.
For example, an employer with an annual wage bill of £5,000,000 across 100 employees would currently have an employers’ NIC liability of approximately £564,000. From the start of the 2025/26 tax year when the changes are implemented, employers’ NIC costs in this example will rise to approximately £664,500, an increase of 17.82%.
In light of the increased costs from April 2025, employers who have not yet implemented pension salary exchange should consider doing so as the savings generated will become even more attractive from a tax perspective. Similarly, employers may wish to consider bringing forward the payment of bonuses to employees relating to the FY24 performance year.
Employers will also need to consider the wide-reaching impact of this change, including the cost of employee benefits and engaging with off-payroll workers.
The Government has created a Corporate Tax Roadmap to communicate its intentions for key areas of the Corporation Tax regime for the duration of this Parliament. This is intended to provide companies with a stable and predictable tax environment, whilst encouraging long term investment, innovation and growth.
The Government published a Corporate Tax Roadmap setting out the main theme of stability, covering the major features of the tax system for companies and where changes are expected or to be explored.
The Roadmap is intended to address the priorities raised by taxpayers of predictability, stability and certainty.
The main commitments included:
We welcome this initiative and the sentiment behind it. The roadmap is wide ranging and a useful guide to the Government’s intentions for Corporation Tax.
It would be helpful for businesses to be provided with the promised stability, transparency and consultation on Corporation Tax matters, particularly with respect to reliefs that relate to long term business decisions, such as capital allowances and R&D tax relief. Whilst tax changes are expected, the Corporate Tax Roadmap should aid businesses decision making and encourage investment.
Carried interest, a share in the profits of a private equity fund's investment, is currently taxed at 18% or 28%. The Government plans to change this, viewing the current regime as too generous. From 6 April 2025, the capital gains tax rate on carried interest will rise to 32%. From 6 April 2026, all carried interest will be treated as trading profits and subject to income tax as well as national insurance, with a 72.5% multiplier reducing the effective tax rate for ‘qualifying’ receipts. The new regime will build on existing rules and will apply to both employed and self-employed fund managers.
Carried interest is a share in the profits of an investment made by a private equity fund, granted to fund managers, and is contingent on the performance of that investment. Due to its unique nature, carried interest has its own tax regime, which currently sees these distributions taxed at a rate of 18% or 28%. The Government considered this regime too generous and promised to bring in a new tax regime to close a perceived 'loophole'.
What is changing?
Changes will be introduced in two phases:
The new regime will build on top of existing rules and definitions for carried interest. It will not displace the existing disguised investment management fee (DIMF) and income based carried interest (IBCI) rules.
The existing regime will continue to apply until 5 April 2026 to allow time for consultation on the new regime, enabling the definition of qualifying carried interest to be refined.
New regime
IBCI rules already apply to subject specific carried interest receipts to income tax and national insurance. This is the case where the average holding period of the investments, to which the carried interest relates, is less than 36 months, with a blended approach for holdings of 36-40 months.
The new regime will build on this regime and treat any carried interest that is subject to IBCI rules as trading income.
For ‘qualifying investments’, those not caught by the IBCI rules will then see the effective tax rate paid on carried interest reduced by a ‘multiplier’ mechanism.
It is intended that this will reduce the amount of carried interest subject to taxation by 72.5%. For an additional rate taxpayer, this would effectively reduce the rate of tax and national insurance to 34%.
Modification to IBCI rules
The Government plans to modify the IBCI rules, to remove an exemption for carried interest received in connection with employment and subject to employment-related securities (ERS) rules. This will broaden the scope of the rules to catch both employed and self-employed fund managers in future.
A consultation document has also been issued to seek views on further modification to these rules to broaden their application to two suggested areas:
The consultation period will run until 31 January 2025 and it is not expected that further detail will be available before early Spring 2025.
Territorial scope of carried interest
It will continue to be possible for individuals to limit the amount of carried interest that is subject to UK taxation where the investment management services leading to the carried interest were performed outside the UK. This will only apply for individuals qualifying for the new four-year foreign income and gains regime.
However, the reclassification of carried interest as trading income will create a new liability to taxation for non-UK resident individuals who receive carried interest arising in respect of duties performed within the UK.
Private equity is a significant part of the UK economy, serving both as a source of investment for UK businesses and as a key industry within the UK’s financial services sector. Currently, London ranks second only to New York as the world’s leading private equity hub.
Senior executives are now more mobile and flexible than ever. There was concern that any overreach by the Chancellor could prompt these executives, who pay large amounts of tax at the highest tax rates, to relocate to more favourable jurisdictions. This could diminish the sector and reduce long-term capital funding for UK businesses.
Our pre-Budget wishes were for the Chancellor to balance the need for increased tax rates with maintaining the UK’s competitiveness relative to other major economies, as well as to ensure simplicity and consistency in the application of the rules.
While overall tax rates are increasing, it is at least a small consolation that they have not risen significantly relative to the main rate of capital gains tax, now at 24%. It is also helpful that the new regime will build on existing definitions and rules, with a period of consultation on modifications to the definition of qualifying carried interest. However, it is disappointing that there will be no transitional provision for existing carried interest entitlements that are yet to be received.
It also remains to be seen whether these changes, coupled with stricter tax rules and more onerous reporting requirements for individuals moving to the UK, will severely limit the UK’s attractiveness as a hub for private equity.
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