UK: UK Private Equity Funds: Tax-Efficient Structuring

Last Updated: 1 November 2012
Article by Terence Pay

London is home to a number of major private equity (PE) funds and many more boutique investment houses providing important venture capital to growing businesses.

The success of London as a centre for private equity is due in part to the favourable tax treatment available to investors and, in particular, investment managers, which ensures London is home to a considerable pool of industry talent.

Basic Structure

A typical UK PE fund is structured as follows:

Main PE Fund

This is commonly structured as an English or Scottish Limited Partnership (LP). A Scottish LP is particularly suitable as it may hold assets in its own name as a legal entity separate from its partners.

The LP is the vehicle of choice as it is tax transparent for UK tax purposes (and in many but not all other jurisdictions). This ensures no tax leakage at LP level; instead, any tax due on the income and gains of the fund is levied at the level of the investor (limited partner) according to each investor's individual tax status and residence. Investors remain liable to UK tax on UK source income (subject to any tax treaty relief for non-resident investors) but according to UK domestic tax law non-resident investors would not generally be taxable on UK-source dividends or capital gains.

An LP is the perfect vehicle for collective investments as it allows for passive investors (Limited Partners) to ring-fence risk whilst the active investment manager (General Partner) manages assets on their behalf and assumes general unlimited liability. As a collective investment vehicle the fund and its managers will be subject to UK regulatory requirements.

Investors (Limited Partners)

The investors (who may be individuals, an SPV or institutional) subscribe capital to the partnership to be invested by the general partner / investment manager. As a limited partner, liability is limited to capital subscribed, providing the investor remains a passive investor and does not take part in the management of the fund. In practice, a very small proportion of the initial investment fund is subscribed as partnership capital; the vast majority of funds are advanced as partnership loans carrying a favourable rate of interest as an initial return on investment.

General Partner (GP)

The GP is responsible for the management of the partnership and carries unlimited liability, for which reason a limited liability company is often used. Although the GP could directly manage the investments, this is generally delegated to an investment manager in London.

The GP itself will often be incorporated in an offshore jurisdiction (from which it should be managed) in order to mitigate any risk of the entire fund being brought on-shore for tax purposes (in theory this would not have a negative tax impact providing the fund is not viewed as a trading entity, but in practice the GP will be kept offshore to mitigate all such tax risks). The GP will take an annual management fee as a first share of the fund's profits.

Investment Manager LLP

The fund executives will typically form a tax-transparent UK vehicle to act in the UK as investment manager to the GP and hence the fund. An arm's length investment management contract will exist between the GP and the investment manager. A limited Liability Partnership (LLP) is used as at is more suited to such a trading function than an LP, whilst maintaining UK tax transparency. The partners will be subject to UK tax on their profit shares from the LLP but crucially these profit shares will not be subject to employers' Class 1 National Insurance contributions which reduces the overall taxation burden.

Carried Interest LP

Potential entitlement to "carried interest" – i.e. a performance-related share of the fund "super profit" – is the primary incentive for the fund executives. A separate carried interest LP is formed through which the executives contribute a small amount of capital to the fund at the outset, with the intention that the LP will receive the carried interest when the fund reaches "hurdle".

The UK taxation treatment of the receipt of such carried interest for UK resident fund executives has typically been very attractive and has served to make the UK an attractive jurisdiction for fund executives. The use of an LLP as a carried interest vehicle ensures that the capital gain element of the carried interest (typically the principal element of profit) is taxed as a capital gain in the hands of each partner at a maximum rate of 28%, rather than income rates of up to 52%.

Where a corporate vehicle is used as advisor (as with some PE funds), it is still possible to achieve capital gains treatment on the carried interest, despite the fact that the acquisition of the fund's underlying share investments as an employee or director would normally be taxed as an income receipt. The basis of this favourable capital treatment is a Memorandum of Understanding (MOU) between HMRC and the British Venture Capital Association. HMRC undertake in the MOU not to treat the carry acquisition as "employment related securities" providing a number of conditions are met, such as the fact that directors and employees should be paid an arm's length salary.

The availability of entrepreneur's relief on the disposal of a business interest means that it can be possible with appropriate structuring to reduce the overall capital gains tax rate to 10%.

UK Holding Company

A UK (or other) holding company may or may not be appropriate in a fund structure, according to the profile of the underlying investments. If there are overseas investments which are likely to pay dividends then a UK holding company may assist in securing double tax treaty benefits (the fund LP itself would be unable to avail of such benefits as a transparent vehicle). The UK dividend tax exemption should be available for receipts of dividends from qualifying investments by the UK company. It would be important to ensure that capital gains relief is available to the company on an eventual disposal of an investment. The Substantial Shareholding Exemption would apply in cases where at least 10% of the issued shares of the investee company have been held for at least 12 months, providing it is a trading company.


London is a prime location for the private equity industry. One of the attractions of the UK as a jurisdiction is the way in which a PE fund can be structured in a way which is tax efficient both for investors and for the investment managers based in London. Tax leakage at fund level can be eliminated for both UK and non-UK resident investors, whilst the primary profit share for managers can be structured in such a way that it is taxed more favourably as a capital gain.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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