On 28 April 2025, the UK government began a consultation on new draft legislation and HMRC guidance in the areas of transfer pricing, the UK definition of "permanent establishment" (PE) and the UK's Diverted Profits Tax.
As part of the consultation on the changes to the definition of PE, the government has proposed legislative changes to the investment manager exemption (IME) and related changes to HMRC Statement of Practice 1/01, which sets out HMRC interpretation and guidance on the IME.
On the whole, the proposed IME changes are helpful and represent a welcome simplification and reform of the IME. There are, however, some aspects where the government is currently (and in some cases we understand inadvertently – see FN2 below) proposing a tightening of the IME conditions. Funds and managers for whom the IME is relevant will need carefully to consider their IME compliance in the light of the proposed new rules.
When is the IME relevant?
Whenever a non-UK resident person carries on a trade1in the UK through a "permanent establishment" (PE), the non-UK resident is liable to UK tax on its profits from that trade.
However, the definition of PE does not include what is called "an agent of independent status". Thus, where a non-UK resident carries on a trade in the UK through an "agent of independent status", the non-UK resident does not carry on its trade through a UK PE, and so is not liable to UK tax on its profits from the trade.
This is particularly relevant to non-UK residents dealing in financial assets (such as non-UK funds) whose activity may come up to the level of a trade for UK tax purposes, and who have delegated responsibility for conducting that activity on their behalf to a UK investment manager. In such circumstances, the non-UK resident may be liable to UK tax on its trading profits, unless the UK investment manager is an "agent of independent status" (and so not a UK PE).
Because of the difficulties in applying the "agent of independent status" test in the context of non-UK residents with UK investment managers, UK legislation also contains the "investment manager exemption" (IME). This provides that, where the IME conditions are met, a UK investment manager will automatically be treated as an "agent of independent status". In these circumstances, the UK investment manager is not a UK PE of the non-UK resident, and the non-UK resident is not liable to UK tax on its trading profits generated through the activities of the UK investment manager.
The Government's Proposed Changes
New broader definition of "Investment Transaction"
The IME only exempts from UK tax profits arising from so-called "investment transactions". In the past, the definition of "investment transaction" has been a source of complexity, with a need for HMRC to add new asset classes to the definition to ensure these are covered by the IME (sometimes long after the need has become pressing). The government is now proposing a new "exclusionary" definition of "investment transaction" under which all transactions carried out by "investment funds"2will be qualifying "investment transactions" unless specifically excluded. It is expected that the excluded transactions – for which IME protection will not be available – will, as now, be transactions related to UK land and "spot" transactions in physical commodities.
Repeal of the "20% test"
At present, the IME is generally not available in respect of a proportion of the non-UK resident's profits where the UK investment manager (and persons connected to it) holds a greater than 20% beneficial ownership interest in the non-UK resident. This "20% test" can be difficult to calculate and administer in practice in particular as the interests in the non-UK resident held by the UK investment manager and its connected persons are likely to fluctuate over time, and the test is also one of the UK investment manager's "intention" as to the likely level of its holdings over time, which "intention" can be difficult to discern. It is therefore very welcome that the government is proposing the repeal of the "20% test".
The "Independent Capacity" Test
However, the proposed repeal of the "20% test" may cause HMRC to look elsewhere and question more closely how non-UK residents and their UK investment managers are ensuring compliance with the "independent capacity" condition of the IME. Here too there are some interesting proposed changes, some welcome, others less so.
Statement of Practice 1/01 sets out two "safe harbours" which describe circumstances where HMRC will accept that the "independent capacity" condition is automatically met.
The first safe harbour is where the non-UK resident to which the UK investment manager is providing services is a "widely held collective fund" (as defined in SP1/01) or is an entity that is being "actively marketed" with a view to its becoming a "widely held collective fund"3. Here, the government is proposing that any entity which is a "qualifying fund" for purposes of the ownership eligibility conditions of the qualifying asset-holding company (QAHC) regime will automatically also be considered a "widely held collective fund" for IME "independent capacity" purposes.
Additionally, the government is proposing new guidance in SP1/01 on the meaning of "actively marketed". This will require "evidence of ongoing genuine attempts to obtain third party investment into the fund ... with operating on a business-as-usual basis simply with an expectation that the position will rectify itself" being explicitly stated to be insufficient.
The second safe harbour is the "substantial services" test which currently requires that the provision of services by the UK investment manager to the particular non-UK resident in question not be more than 70% of the UK investment manager's total business (determined by reference to fees earned by the UK investment manager, or some other measure where that is considered appropriate). The government's proposal here is that this threshold be reduced to 50%, so that the safe harbour would not be available where the provision of services by the UK investment manager to the particular non-UK resident was more than 50% of the UK investment manager's total business.
It should be recognised that, under the terms of the IME itself, these two tests continue only to represent "safe harbours" under which the "independent capacity" condition of the IME will be deemed to be met. It remains open to funds and their UK investment managers to meet the "independent capacity" condition on the basis that their relationship is, viewed in the round and having regard to its legal, financial and commercial characteristics, a relationship between persons carrying on independent businesses that deal with each other at arm's length.
IME not an exclusive exemption
The existing legislation provides that a UK investment manager will be regarded as an agent of independent status of its non-UK resident clients "if, and only if" the IME is met. This has led many to draw the conclusion that UK investment managers are a special case, and that a UK investment manager can be an agent of independent status only if the IME is met. The draft legislative changes propose the removal of the "if, and only if" wording, thereby confirming that it is open to a UK investment manager to qualify as an agent of independent status (and hence not a UK PE) by relying on the general test, even if some of the specifics of the IME conditions are not met such that the IME is not available.
Conclusions
The Consultation Document states that the government's intention in undertaking a critical review of the IME legislation is to clarify the IME's operation and make it easier for taxpayers to apply, so as to ensure that the IME remains fit for purpose. Our view is that the government's proposed amendments would be largely successful in achieving these policy aims, although UK investment managers will need to consider carefully the impact of the proposed changes on their particular fact pattern.
We plan to contribute the views of our clients as part of the consultation process, and would welcome your views on the changes (in writing or by way of discussion) to feed into our response which is due by 7 July 2025. We hope that the government will be open and responsive to this industry feedback.
Footnotes
1. What kinds and nature of activity amount to a "trade" for UK tax purposes is determined on the basis of UK case law and can be difficult to decide in practice. This is particularly the case for activity in financial assets, as most of the case law is concerned with more mundane activity in widgets and other physical assets. Traditionally, many non-UK funds have taken a conservative approach and assumed that they are trading (and so must meet the IME conditions), unless it is very clear that their activity is one of long-term investing and cannot be considered trading.
2. The definition of an "investment fund" for these purposes is any entity which is, for UK regulatory law purposes, either an "alternative investment fund" or a "collective investment scheme". If the government were to proceed with the new proposed definition of "investment transaction" – whereby only transactions entered into by "investment funds" could be "investment transactions" – this would represent a substantial narrowing of the scope of the availability of the IME, which can currently be utilised by any non-UK resident, and not only by "investment funds". However, we understand from discussions with government representatives that this apparent restriction is unintended, and that the intention is that the IME will, as currently, continue to be available to any non-UK resident where the IME conditions are met.
3. Or is being wound up or dissolved.
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.
