The UK Concept of Base Cost Shift

Transcription

1 The UK Concept of Base Cost Shift Jenny Wheater February Duane Morris LLP. All Rights Reserved. Duane Morris is a registered service mark of Duane Morris LLP. Duane Morris Firm and Affiliate Offices New York London Singapore Philadelphia Chicago Washington, D.C. San Francisco Silicon Valley San Diego Boston Houston Los Angeles Hanoi Ho Chi Minh City Atlanta Baltimore Wilmington Miami Boca Raton Pittsburgh Newark Las Vegas Cherry Hill Lake Tahoe Myanmar Oman Mexico City Duane Morris LLP A Delaware limited liability partnership

2 What is base cost? Capital gains tax applies to capital gains, not capital receipts. Your gain is the difference between what you sell an asset for and what it cost you to buy it. Your base cost is what the asset cost you. In the US base cost is known as basis. 1

3 What is base cost? So: if you purchase shares in a portfolio company for 10 and sell for 20 your base cost is 10 and your gain is 10 You pay tax on 5 at 45%, so your tax bill is This example assumes UK additional rate tax is payable, currently 45%. 2

4 How does this apply to partnerships? HMRC Statement of Practice D12 (SP D12) sets out how, in practice, HMR will apply s59 Taxation of Chargeable Gains Act 1992 to partnerships. Each partner in a partnership has an interest in each of the assets of the partnership for tax purposes. Applies for tax purposes even to tax transparent LPs with a legal personality (such as a Scottish LP), even if legally, the LP owns its own assets. Concept can apply to UK partners who hold their interest through a partnership formed in another jurisdiction (e.g. Delaware, Cayman). 3

5 SPD 12 Example A B C D Partnership T1 T2 T3 Assuming they are equal partners, A, B, C and D each own 25% of each share in T1, T2 and T3 4

6 Paragraph 4 SPD12 When there is a change in profit sharing ratios in a partnership, partners whose shares are reduced are treated as making a disposal of the relevant part of their share and partners whose share is increased are treated as making an acquisition of the relevant part of their share. 5

7 Operation of SPD12 A B C D E (new partner) Partnership T1 T2 T3 Again, assuming they are equal partners, prior to E becoming a partner, A, B, C and D will own 25% of each of the shares in T1, T2 and T3. When E joins, A, B, C and D will be treated as disposing of 5% of each of their shares in T1, T2 and T3 and E will be treated as acquiring these 6

8 SPD12 disposal at what cost? Paragraph 4 of SPD12 provides that the disposal/acquisition when a change in profit sharing ratios occurs is treated as being at the original capital gains base cost of the disposing partner. 7

9 A B C D E Partnership T1 T2 T3 A, B, C and D, as partners acquired T1 for 200. Two years later T1 is worth 1,000. E joins the partnership at this point and, as per SPD12, is treated as acquiring 20% of each of the shares in T1, while A, B, C and D are each treated as disposing 5% of them. E pays nothing for his partnership interest. 8

10 Base cost analysis E s admission A, B, C and D will each be treated as disposing of 5% of all the shares in T at their base cost, namely 5% of 200 each, i.e. 10 each no gain/no loss to them. E is treated for tax purposes as acquiring 20% of each of the shares in T1 for 40. E inherits the 10 base cost of each of A, B, C and D. Thus, A, B, C, D and E now all have a 40 base cost in T1 totalling the 200 paid by A, B, C and D. 9

11 Base Cost Analysis Disposal of T1 T1 is sold for 1,000, and A, B, C, D and E each receive proceeds of 200. A, B, C, D and E are treated as each having a gain of 160, reflecting their base cost of 40. In reality, E, who paid nothing for his interest, has taken the benefit of A, B, C and D s base cost. This is essentially how the base cost shift works! 10

12 Base Cost Analysis Disposal of T1 Amount Spent Base Cost at Disposal Chargeable Gain Tax Paid (at 45%) A B C D E Total Net Profit 11

13 Instead of (without base cost shift) Amount Spent Base Cost at Disposal Chargeable Gain Tax Paid (at 45%) Net Profit A B C D E Total

14 Or (if E had bought his interest for 40) Amount Spent Base Cost at Disposal Chargeable Gain Tax Paid (at 50%) A B C D E Total Net Profit 13

15 Base cost shift application to funds When the carry kicks in there is a change in the profit sharing ratios of the fund partnership. This means that, just as with the example above, investors are treated as disposing of a part of their interest for the amount they paid (their base cost) and carryholders are treated as acquiring. Thus the base cost of the investors shifts to the carryholders. Thus carryholders take the benefit of the investors base cost in their capital gains. 14

16 Why don t investors object? Many investors in private equity funds are tax exempt. As they pay no tax on their chargeable gains, the base cost is of no benefit to them. The base cost shift does have an adverse effect on investors who are UK taxpayers. It is the way the law operates and has operated for some time and thus has become accepted. 15

17 Further information Jenny Wheater, Partner, London +44(0)

18 The UK Concept of Base Cost Shift Jenny Wheater February Duane Morris LLP. All Rights Reserved. Duane Morris is a registered service mark of Duane Morris LLP. Duane Morris Firm and Affiliate Offices New York London Singapore Philadelphia Chicago Washington, D.C. San Francisco Silicon Valley San Diego Boston Houston Los Angeles Hanoi Ho Chi Minh City Atlanta Baltimore Wilmington Miami Boca Raton Pittsburgh Newark Las Vegas Cherry Hill Lake Tahoe Myanmar Oman Mexico City Duane Morris LLP A Delaware limited liability partnership