The UK’s high rate of income tax has been causing problems for partners at hedge funds. This is how they are mitigating it

The UK’s 50% higher rate of income tax – to be reduced to 45p next April – has been causing headaches for hedge funds.

The problem, according to Christopher Groves, a partner in the tax team at legal firm Withers, is that all the profits of a partnership are treated as income and therefore taxed (if over £150k) at 50% in the year they arise.

This is causing problems for hedge funds which want to reinvest that money in the business, or who want to set up long term incentive plans in order to pay their employees.

To sidestep this issue, Groves says that ever since the 50p tax rate was introduced, an increasing number of hedge fund partners have been setting up companies which effectively act as a ‘corporate partner,’ and take a share of the profits.

A quick look at the FSA register for various leading hedge funds inLondonreveals several companies directed by hedge fund partners listed among the ‘registered individuals’ working for that fund.

Stuart Mclaren, a financial services partner at Deloitte, says these ‘corporate members’ are increasingly common in London hedge funds, and can be a way for partners to reduce their own income tax payments. “You see people paying quite large sums of money to the corporate member, which will then pay people in the form of a dividend – which attracts a lower rate of tax.”

Typically, however, Groves says money paid to ‘corporate partners’ is simply reinvested in the business, or used to fund hedge funds’ long term incentive schemes.

He says there’s little point in individual hedge fund partners paying themselves in this way because the money paid to the corporate partner will attract first corporation tax and then dividend tax. Combined, these equate to around 49% and are therefore on a par with the higher rate of income tax as it currently stands.