On 28 April 2025, the UK government published draft legislative amendments to:
-
Align the UK’s domestic tax
rules on permanent establishments (PE) with the 2017 Organisation for Economic
Co-operation and Development (OECD) Model Tax Convention. -
Modernise the Investment
Manager Exemption (IME).
This followed a consultation launched in 2023 and a lengthy period of
engagement with industry stakeholders on the proposed legislative amendments.
The UK’s existing PE and IME rules, some of which are over 20 years old, have
grown increasingly out of step with international norms and the practical
realities of the asset management industry. HM Revenue & Customs’ (HMRC’s)
goal with these amendments is to provide greater clarity and modernity for
taxpayers in the context of cross-border investment management arrangements.
Summary of the Amendments Relevant to UK Asset Managers
Domestic Law – Basic PE Definition
The draft amendments introduce a number of significant changes to the UK’s
domestic tax legislation, with particular relevance for nonresident investment
funds and UK-based investment managers.
-
The definition of a
“dependent agent” PE in UK law is updated to reflect Article 5 of the 2017
OECD Model Tax Convention. The new definition focuses on whether a person
habitually concludes contracts — or habitually plays the principal role
leading to the conclusion of contracts — without material modification by the
nonresident. -
The exemption for agents of
independent status is narrowed, in line with the 2017 OECD Model. Independence
is now precluded where the agent acts exclusively or almost exclusively for
one or more companies to which it is “closely related” (i.e., under
common control or meeting a 50% investment condition).
The IME
The proposed amendments to the definition of “dependent agent” PE and
exemption for agent of independent status may bring a larger number of
arrangements within the scope of the UK charge to tax. The government accepts
that this could adversely affect nonresident trading vehicles with UK-resident
managers, and have therefore proposed certain changes to the IME.
-
The IME is clarified as an
interpretation of the general agent of independent status exemption, rather
than an exclusive provision. This means that if the IME is not met, the
general agent of independent status exemption may still technically be
available. -
The “20% rule” (Condition
D), which previously limited the IME where the investment manager and
connected persons were entitled to more than 20% of the nonresident’s profits,
is repealed. The partial charging provision is also removed. -
A new statutory definition
of “investment transaction” is introduced, which is exclusionary and therefore
wider. (Transactions relating to UK land and physical commodities remain
specifically excluded.)
In addition, the government published a revised draft Statement of Practice on
the treatment of investment managers and their overseas clients (SP 1/01).
Notably, the revisions to the Statement of Practice clarify how HMRC will
apply the “independent capacity” test (Condition C of the IME).
In particular:
-
A new characteristic can be
used to demonstrate independence for the purposes of Condition C of the IME:
that the nonresident is a “qualifying fund” for the purposes of paragraph 9(1)
Schedule 2, Finance Act 2022. -
There is new guidance on
what is required for a fund to be “actively marketed”. -
The maximum threshold for
the proportion of the investment manager’s business conducted with the
nonresident to still demonstrate independence is reduced from 70% to 50%.
Takeaways for UK Asset Managers
The IME is a cornerstone of the UK’s attractiveness to the asset management
sector, providing certainty — as long as certain conditions are met — that
nonresident funds can appoint UK-based investment managers without triggering
a UK tax charge on trading profits.
The amendments, if enacted, would represent the most significant reform of the
IME since its introduction and would be broadly positive for the sector. They
would also introduce new compliance considerations.
In the main, the changes to the IME are welcome and represent an encouraging
signal from government to the UK asset management sector. In particular, the
proposed removal of the “20% rule” and widening of the scope of the IME to
cover a wider range of transactions on a exclusionary basis are expected to
significantly simplify compliance with the IME and future-proof the regime.
The “20% rule” had never been a bright-line test anyway, given the “intention”
component, which had led to some implementation difficulties by managers.
The removal of the “if and only if” wording clarifies that the IME is an
exemption available in addition to the general agent of independent
status exemption, rather than as the exclusive exemption applicable to
investment managers. However, the amended agent of independent status
exemption would be narrower than that currently adopted by the UK in its
international tax treaties; there is therefore a question as to whether funds
structured in treaty jurisdictions would maintain an advantage by relying on
the treaty exemption rather than the UK domestic exemption (at least if and
until such treaties are amended in line).
When establishing new structures, choosing established treaty jurisdictions
such as Ireland or Luxembourg may provide more flexibility — access to local
talent pools and infrastructure, optionality between the domestic and treaty
path to exemption for investment managers, access to political counterweight
through a jurisdiction looking to retain taxing rights in accordance with
their treaty with the UK (including through the Mutual Agreement Procedure
(MAP)).
Additionally, in the SP 1/01, HMRC noted that it does not consider that a
manager failing the IME would be able to succeed under the general domestic
exemption; although nonbinding guidance, it is clear that HMRC would have a
presumption against independence for managers that fail the IME.
Should the 20% rule be abolished, if one of the remaining IME conditions are
failed, all trading income attributable to the UK PE of a nonresident fund
(including income arising from third-party capital unconnected to the manager)
would become chargeable to UK tax.
This places increased scrutiny on the remaining conditions, particularly the
“independent capacity” test (Condition C). It is unclear how this increased
scrutiny will play out in audits and enforcement actions. HMRC has often been
focused on the “20% rule”, and its removal raises the question of which
condition HMRC will focus on moving forward.
The conditions to meet the ”independent capacity” test are currently largely
found in the SP 1/01. The government is continuing with this approach, as the
revisions to the scope of the “independent capacity” test are found in the
amendments to the SP 1/01 rather than the proposed statutory amendments.
Even though reliance on the SP 1/01 has generally been viewed favourably, as
it provides both HMRC and taxpayers with flexibility, in light of the recent
adverse judicial treatment given to HMRC guidance by the Court of Appeal in
HMRC v BlueCrest Capital Management (UK) LLP, the fact that the
“independent capacity” test continues to heavily rely on nonbinding guidance
in its application may fail to provide taxpayers with the degree of certainty
that the reform is meant to achieve.
The test seems to have been both expanded and narrowed:
-
Expanded, by stating that
“qualifying funds” as defined under the Qualifying Asset Holding Companies
regime meet the “independent capacity” test regardless of whether they are
widely held. -
Narrowed, by providing
stricter guidance on the meaning of being “actively marketed”, and lowering
the threshold for the substantial services test to 50% rather than 70%.
Nonresident funds that are not “qualifying funds” will be faced with fresh
compliance challenges. Of particular concern is the statement in SP 1/01 that
“[o]perating on a business-as-usual basis with an expectation that the
position will rectify itself is not sufficient”, as this may put significant
pressure on capacity-constrained funds to show active fundraising efforts that
demonstrate they are being actively marketed with the intention of becoming
widely held.
The asset classes that are eligible for the IME are also seemingly being
widened by making the definition of “investment transactions” exclusionary
(although UK land and physical commodities remain excluded). We expect this
change to be generally a positive development, as it will allow the IME to
remain relevant as new asset classes emerge without the need for further
extensive engagement to expand the list (as was the case for cryptoassets,
which were only added to the list — with exclusions — in the 2022-23 tax year
after years of industry engagement).
The new definition, however, is restricted to transactions of an “investment
fund” (defined by reference to UK regulatory rules). This is a new limitation,
as currently the IME is not limited to regulated funds, which could create
issues for asset holding companies that carry out investment transactions (for
instance, in a credit fund context).
It remains to be seen whether government will be open to industry feedback on
this new limitation through the consultation process. We also note that the
IME remains available for funds that carry out a mix of excluded and
nonexcluded investment transactions; such funds could still access the IME for
trading income arising from nonexcluded investment transactions, so that the
charge to UK tax would be limited to trading income arising from any excluded
investment transactions.
This memorandum is provided by Skadden, Arps, Slate, Meagher & Flom LLP and its affiliates for educational and informational purposes only and is not intended and should not be construed as legal advice. This memorandum is considered advertising under applicable state laws.
