Part 1 – Choosing the right structure: For any Alternative Investment Fund Manager (AIFM), the main factors that define the success of their business will be the amount of capital they are able to raise and the performance of the funds that they manage.
Part 1 – Choosing the right structure
For any Alternative Investment Fund Manager (AIFM), the main factors that define the success of their business will be the amount of capital they are able to raise and the performance of the funds that they manage.
Administrative matters are quite rightly a secondary concern, but it is still important these are dealt with competently as failure to do so may result in the AIFM incurring fines and penalties, breaching its regulatory requirements with the Financial Conduct Authority (FCA) or paying too much tax.
In this short series of articles, Blick Rothenberg Partner Peter Scott summarises the various filing requirements of a new UK-based AIFM and other issues it may face.
We hope these insights help you to manage your business in a proficient manner which frees up as much time as possible for you to concentrate on improving the performance of the funds you manage.
Before setting up the AIFM you will need to decide on your preferred legal structure. Most AIFMs in the UK are incorporated as either companies or Limited Liability Partnerships (LLP’s). The choice is typically made based mainly on tax considerations, but there are other aspects which should be taken into account.
Taxation of profits
A company pays Corporation Tax on its profits (the rate is currently 19% with a planned rise to 25% in April 2023 on profits over £250,000). It can then choose to retain these profits in the business or to pay them out to shareholders as a dividend on which Income Tax is paid (the current top rate is 39.35%). The combined corporation and dividend tax rate on profits paid to additional rate taxpayers (individuals with an income over £150,000) works out to be around 51% (and will rise to around 55% once the Corporation Tax rate increases).
An LLP must apportion its profits among its partners and it will then be the responsibility of each individual partner to pay Income Tax on his/her share of the profits. If the partner has income over £150,000 they will pay Income Tax at a rate of 45% and National Insurance at a rate of 3.25% meaning a combined tax rate of 48.25%.
The exact tax rates depend on the circumstances and level of income of the individual and the business but in general profits in LLPs and companies are roughly subject to the same tax rates, although we do not know what changes to tax rates may occur in the future.
Companies may benefit from a timing difference in that tax is only payable on dividends once they are paid. Therefore, if a company wishes to retain its profits and use them to fund growth of the business, it need only pay Corporation Tax. Income Tax must be paid on all profits attributable to partners in an LLP, regardless of whether or not those profits have been paid over to them.
An advantage of LLPs is that they are more flexible than companies when it comes to sharing profits and admitting new members. When a company distributes profits, it must distribute these to its shareholders in the same proportion as their shareholdings.
When an LLP distributes profits the amounts distributed to each partner can be decided at the LLP’s discretion.
An LLP can appoint a new partner relatively easily. All that is required is an amendment to the internal partnership agreement plus the standard notifications to the Financial Conduct Authority and Companies House – whereas for a company to admit a new shareholder it must issue new shares or transfer existing shares. This is a more convoluted process and may have tax implications if the new shareholder does not acquire his/her shares at market value.
LLPs with corporate members
Some AIFMs are set up with a mixed structure. An LLP is set up as the AIFM, but a company is also set up and that company becomes a partner in the LLP. In the past this has enabled AIFMs to get the best of both worlds whereby profits are still allocated on a flexible basis but any profits the AIFM wishes to retain in the business can be allocated to the corporate member and are therefore only subject to Corporation Tax at 19%.
However, the benefits of this structure are no longer quite as appealing.
Since April 2014, any excess profits allocated by an LLP to its corporate member have instead been taxed on the individual partners. Therefore, it is no longer possible for an LLP to shelter significant profits in its corporate member.
As long as the AIFM is only seeking permission to manage a fund and does not intend to hold client assets or client money, it will usually be required to hold regulatory capital of at least the higher of:
• €125,000 plus 0.02% of the amount by which assets under management exceed €250m (limited to €10m); or
• A quarter of its annual fixed expenditure.
This will need to be injected into the AIFM either as share capital (for a company) or partners’ capital (for an LLP). It may also be possible to inject some regulatory capital in the form of loans, but this is subject to strict rules.
If the AIFM is an LLP, the partnership agreement must specify that partners’ capital can only be withdrawn in the following circumstances:
• The partner withdrawing the capital ceases to be a partner and an equal amount of partnership capital is injected into the LLP by the other partners
• The LLP is wound up or dissolved or ceases to be authorised by the FCA
If this is not specified in the partnership agreement, then partners’ capital will not count as regulatory capital. If the AIFM makes a loss, or anticipates making a loss, then it should inject further capital into the business if necessary to maintain regulatory capital at the required level. The AIFM must notify the FCA whenever it injects or repays regulatory capital.
The AIFM will also be required to hold core liquid assets (usually taken to mean cash in sterling denominated bank accounts) of at least a twelfth of its annual fixed expenditure.
• The AIFM must hold regulatory capital of at least €125k or a quarter of annual expenditure
• The FCA must be notified whenever regulatory capital is injected or repaid
• Restrictions apply to repayment terms of regulatory capital
How Blick Rothenberg can help
We hope that you have found this article helpful in giving you an understanding of some of the general issues and requirements you will face in setting up an AIFM.
While this series of articles focuses on general issues applicable to most UK AIFMs there may be some issues specific to your circumstances which also need to be considered. If you would like to discuss any of the content of this article further, please contact Peter Scott directly via [email protected].
For all our latest Financial Services news and insights, visit our Financial Services hub here.