Finalised guidance on reformed investment manager exemption published

The IME is a longstanding plank of the UK's tax regime. It is designed to support the UK investment management sector by giving comfort to non-resident investors that they will not be subject to UK tax on transactions, simply because they are conducted on their behalf by UK managers. In practice, the IME is more important for some strategies (such as hedge funds) rather than others. This is because it protects against tax charges on trading income, and, for many strategies (such as private equity and infrastructure), it is generally possible to get comfortable that the investor is not trading.    

The recent Finance Act 2026 contained a package of measures relating to international taxation, including an expansion of the UK's domestic law definition of "permanent establishment" - which is the level of presence in the UK typically needed to bring non-resident traders within the corporation tax net.  To allay concerns that this could adversely affect the asset management sector, the legislation underpinning the IME was reformed to make the exemption more accessible.

In addition to the IME legislation, there is a detailed HMRC statement of practice (the SoP) setting out how HMRC considers that the IME should be applied in practice. Last Friday, the final updated version of the SoP was published.

Many of the changes to the SoP follow on from the changes to the legislation. In particular, the SoP now reflects:

• the broadened scope of the IME, so that it applies to a wider range of transactions. The IME already applied to a broad spectrum of transactions, so this change, although helpful, is unlikely to materially impact on most non-resident investors; and
  
  
• more significantly, the removal of one of the previous qualifying conditions for the IME to apply. This was the "20% test" or "Condition D", and, broadly, it required the investment manager (and its connected persons) not to be entitled to more than 20% of the non-resident's profits deriving from the manager's activities. This could be difficult to apply in practice, especially in the context of funds with carried interest and co-investment arrangements, so its removal is particularly welcome.  

In addition to reflecting the legislative reforms, the amended SoP makes some significant changes to how HMRC say they will apply the IME, particularly in relation to two of the qualifying conditions. 

The independent capacity test ("Condition C")

This condition, essentially, requires that the relationship between the manager and the non-resident is that between persons carrying on independent businesses dealing with each other at arm's length.  Importantly, the SoP sets out safe harbours relating to investment funds which, if they apply, mean that HMRC will consider that Condition C has been satisfied.

A difficulty with the previous version of the SoP was that it did not expressly explain how the safe harbours should be applied to transparent funds. As the funds are essentially "look through" for tax purposes, the correct approach appeared to be to apply the safe harbours at investor level, however, the wording of the safe harbours appeared to blur the issue by assuming that the non-resident would be the fund itself.  

The amended SoP brings some helpful clarity. It confirms that:

• the independent capacity test is applied at the level of the relevant non-resident. This means that, for transparent funds, the question is whether the manager is independent from the investors, whereas, for opaque funds, it is whether the manager is independent from the fund itself, but
  
  
• in both cases, the same safe harbours apply at the level of the fund – and so, in the case of transparent funds, the safe harbours are based on the features of the fund itself (e.g. whether it is "widely held"), rather than those of any non-resident investor in the fund.

In addition, the SoP inserts an additional safe harbour. Condition C will now be taken to be met where the fund is a "qualifying fund" for the purposes of the UK's qualifying asset holding company (QAHC) tax regime.

However, it is not all good news. The amended SoP restricts the scope of one of the safe harbours. Previously, Condition C was taken to be met where the provision of services to the non-resident (and persons connected with it) did not exceed 70% of the investment manager's business, but that has now been reduced to 50%.

The customary rate test ("Condition E")

This condition, essentially, requires that the remuneration the investment manager receives for the provision of investment management services to the non-resident is not less than is customary for the services.

In a welcome change from the previous version, the SoP now expressly deals with carried interest. It confirms that an overall reward package comprising of management fees and carried interest on terms which have been negotiated with investors at arm's length will be taken to satisfy the customary rate test.

Following on from the helpful changes to the IME legislation, the publication of the updated SoP is another welcome development. This is both because the reformed IME legislation has had effect since 1 January – so the final updated guidance is somewhat overdue, and because the updated SoP contains important clarifications for investors in transparent funds and in relation to carried interest arrangements.