An investigation into the normal tax implications of a carried interest received by fund managers

Troost, Tertius (2016-03)

Thesis (MAcc)--Stellenbosch University, 2016.

Thesis

ENGLISH ABSTRACT: The term “a carried interest” - which refers to the right held by a private equity fund manager to share in the future profits generated by the investment fund that it manages - is not defined in the South African Income Tax Act 58 of 1962 (the Act), nor has it been under scrutiny of the South African courts. Consequently, there is uncertainty regarding the classification of the initial receipt of a carried interest and the cash flow from a carried interest for normal tax purposes in South Africa. Due to this uncertainty this research was undertaken. It consists of a literature review of pure theoretical aspects of published theoretical and descriptive material. The wording of the Act with specific reference to the gross income definition and the phrases “amount received in respect of services rendered” and “of a capital nature” was scrutinized, together with relevant case law and academic articles. The aim of this study was to determine the nature of a carried interest for normal tax purposes when distributed to the fund manager of an investment fund. In order to address this it was needed to determine: o whether the initial distribution of a carried interest by an investment fund to a fund manager constitutes a fringe benefit o whether a carried interest distributed by an investment fund to a fund manager constitutes gross income in terms of other provisions of the Act o the nature of the cash flow from a carried interest, for normal tax purposes, earned by the investment fund upon the liquidation of the fund o the effect of section 9C of the Act on the underlying investments of, and consequently on a carried interest in, an investment fund o the effect of the guidelines formulated by the South African courts on the underlying investments of, and consequently on a carried interest in, an investment fund It was determined the fund manager performs its services independently of the investment fund. As a result the initial receipt of a carried interest cannot be regarded a fringe benefit. Furthermore, reference to the definition of gross income and substantiating case law indicated that the receipt of a carried interest does not constitute gross income, because the fund manager only receives an entitlement to share in future profits of the investment fund, which does not constitute an amount as defined by case law. Hence the study progressed to the cash flow from a carried interest. It was concluded that the cash flow from a carried interest has a closer relationship with the risking of capital than with the provision of services. Therefore, the amount received is not classified as an amount received in respect of services rendered. The nature of the underlying investments were investigated and presented the conclusion that the investments are normally held with the dominant intention for resale, and thus are income in nature. However, the overriding effect of section 9C of the Act makes it possible for the underlying investments to be deemed capital in nature if certain requirements are met. The carried interest regime was examined in the USA and the Netherlands and was compared to South Africa. It was concluded that the lack of specific legislation in South Africa is requires thoroughly researched legislation that would provide a clear answer to the method of taxing a carried interest without causing loss of foreign investment.

AFRIKAANSE OPSOMMING: Die begrip “a carried interest” - wat verwys na die reg wat 'n private aandelefonds bestuurder uitoefen om te deel in die toekomstige winste wat deur die beleggingsfonds wat hy bestuur, gegenereer word - is nie gedefinieer in die Suid-Afrikaanse Inkomstebelastingwet 58 van 1962 (die Wet) nie en is ook nie deur Suid-Afrikaanse howe ondersoek nie. Gevolglik, is daar onsekerheid oor die klassifikasie van die aanvanklike ontvangste van 'n carried interest, asook die kontantvloei van 'n carried interest vir doeleindes van normale belasting in Suid-Afrika. As gevolg van hierdie onsekerheid is hierdie navorsing onderneem. Dit bestaan uit 'n literatuurstudie van suiwer teoretiese aspekte van gepubliseerde teoretiese en beskrywende materiaal. Die bewoording van die Wet is onder die loep geneem, met spesifieke verwysing na die omskrywing van bruto inkomste, die frases "bedrag ontvang ten opsigte van dienste gelewer" en "van 'n kapitale aard”, asook relevante regspraak en akademiese artikels. Die doel van hierdie studie was om die aard van 'n carried interest te bepaal vir doeleindes van normale belasting, wanneer dit aan die fonds bestuurder van 'n beleggingsfonds uitgekeer word. Ten einde dit aan te spreek,was dit nodig om: o vas te stel of die aanvanklike uitkering van 'n carried interest deur 'n beleggingsfonds na 'n fondsbestuurder 'n byvoordeel uitmaak; o vas te stel of 'n carried interest, uitgekeer deur 'n beleggingsfonds aan 'n fondsbestuurder, bruto inkomste uitmaak; o die aard van die kontantvloei vanaf 'n carried interest vir normale belasting doeleindes, soos verdien deur die beleggingsfonds by likwidasie van die fonds, vas te stel; o die effek van artikel 9C van die Wet op die onderliggende beleggings van 'n beleggingsfonds vas te stel; o die effek wat die riglyne, soos deur die Suid-Afrikaanse howe geformuleer, op die onderliggende beleggings van, en gevolglik op ‘n carried interest in, 'n beleggingsfonds vas te stel. Daar is vasgestel dat die fondsbestuurder sy dienste onafhanklik van die beleggingsfonds verrig. As gevolg daarvan kan die aanvanklike ontvangste van 'n carried interest nie as ‘n byvoordeel beskou word nie. Verdere verwysing na die omskrywing van bruto inkomste en stawende regspraak, het aangedui dat die ontvangste van 'n carried interest nie bruto inkomste uitmaak nie. Die rede hiervoor is dat die fondsbestuurder slegs 'n reg ontvang om in die toekomstige winste van die beleggingsfondse deel. Hierdie reg kan nie 'n bedrag, soos gedefinieer in regspraak, uitmaak nie. Vervolgens fokus die studie op die kontantvloei ontvang vanaf 'n carried interest. Die gevolgtrekking was dat hierdie kontantvloei 'n nouer verband het met kapitaalrisko as met die voorsiening van dienste. Daarom is die ontvangste nie geklassifiseer as 'n bedrag ontvang ten opsigte van dienste gelewer nie. Die aard van die onderliggende beleggings is ondersoek en die gevolgtrekking was dat die beleggings normaalweg gehou word met die primêre bedoeling vir herverkoop, en dus is dit inkomste van aard. Die oorheersende effek van artikel 9C van die Wet maak dit egter moontlik vir die onderliggende beleggings om as kapitaal van aard geag te word, indien daar aan sekere vereistes voldoen word. Die carried interest regime van die VSA en Nederland is ondersoek en vergelyk met Suid-Afrika. Die gevolgtrekking was dat die gebrek aan spesifieke wetgewing in Suid-Afrika deeglike navorsing ten opsigte van wetgewing, wat 'n duidelike antwoord gee op die metode van belasting ten opsigte van 'n carried interest, vereis. Nuwe wetgewing moet egter nie ‘n verlies aan buitelandse belegging veroorsaak nie.

Please refer to this item in SUNScholar by using the following persistent URL: http://hdl.handle.net/10019.1/98362
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