Social Care Levy and Investment Managers

In September, the government announced the new social care levy that will apply from April 2022. The charge will see an increase of 1.25% to NIC rates, for employees, employers and the self-employed, for the 2022-23 tax year, with the levy then collected as a separate tax from April 2023.

However, whilst the newspaper headline of this new levy related to the increase in tax on individual’s employment and self-employment income, the charge will also add 1.25% to the dividend tax rate.

Investment managers will obviously be affected by the change in respect of their employment /self-employment income. However, where investment managers also hold co-invest and carry allocations in their funds, they are likely to be further impacted and see an increase in their tax liabilities. This will occur where the return received from the carry and co-invest funds is received in the form of a dividend (which can include disallowed interest).

Typically, a UK investment fund will invest in assets (portfolio companies) via loan notes, preference shares and ordinary share capital. During the life of the fund the loan notes held will pay interest and this will be assessable on the partners/owners of the fund.

At first glance an investment manager may not believe that they have received any dividends, as the fund has received interest on loan notes held. However, where a portfolio company is unable to claim a deduction in its corporation tax return for the interest incurred, then the interest disallowed is assessed as a dividend/distribution on the recipient rather than as interest.

Prior to April 2022, this would have resulted in a tax saving for the investment manager, holding carry and co-invest returns, of 6.9%, (38.1% dividend tax compared to 45% income tax), assuming the individual is an additional rate tax payer. However, post April 2022 the tax saving is reduced to 5.65%, due to the increase in the dividend tax rate to 39.35%.

An example

Individual A is a member of a co-invest scheme and receives an interest payment of £10,000 in respect of their share of loan notes held by the fund. They are advised that the portfolio company to which this interest payment relates has only been able to take a 40% interest deduction. Individual A is thus deemed to have received a dividend of £6,000. They have other personal dividends that utilise the dividend allowance of £2,000 and are an additional rate taxpayer.

Prior to April 2022 a £2,286 tax liability on the £6,000 dividend would have arisen (£6,000 x 38.1%). Post April 2022 a £2,361 tax liability arises on the £6,000 dividend.

Actions to take

The impact of the changes is largely out of control of the individual investment managers, but investment managers should be aware of the changes and how this potentially impacts their future tax liabilities and whether any cashflow planning is required.

Where funds have the ability to roll dividends and sell the shares they have invested in cum-div (normally seen in preference shares) there is now a larger disparity between the dividend tax rate and capital gains tax rate, which may impact behaviour (i.e. whether a dividend is paid or rolled to exit).

For more information on the issues raised above or to discuss your circumstances, get in touch with Alex Conway or your usual Crowe contact.