Leaving LLP hedge fund

Our client was leaving a hedge fund LLP, of which he was a member. He was also a shareholder in a private company that was a corporate member of the LLP. The hedge fund also operated an off-shore trust vehicle. Our client planned to resign and transfer his shares. Part of our client’s payment depended upon future income generated by our client’s trades.

We advised him on his income and capital gains tax, as well as negotiating his settlement and severance agreement.

Tax on earn-outs from a hedge fund

The first step in the process was explaining how HMRC tax earn-outs in instances such as these, in which the eventual total consideration payable cannot be quantified at the time the deal is struck. We worked with accountants to value the earn-out.

Our client would lose entrepreneurs relief on capital gains when some elements of the earn-out become payable, as he would no longer be a partner. Hence our client had two options.

First option

Our client could pay capital gains tax on the right to the earn-out at the time of disposal. This would be when he resigned.

Second option

The second option would be to pay more tax when the earn-out could be exactly quantified when he was paid.

Entrepreneurs’ relief on capital paid out by the hedge fund

Our severance agreement from the LLP clearly defined which elements were taxable as income, and which qualified for capital treatment. Capital gains tax was payable at a much lower rate than income tax. We also ensured our client utilised the 10% entrepreneurs’ relief tax exemption. We obtained advance clearance from HMRC on the total deal which provided clarity on the tax treatment. That clarity then carried the deal through to signing.

Settlement agreement offered by the hedge fund

The settlement agreement had to include precise wording to support the tax position our hedge fund manager wanted to achieve.  There were commercial requirements needed to protect our client's reputation in the market.

This involved negotiating the non-compete and non-poaching of client agreements. Additionally the hedge fund possessed valuable intellectual property (IP) in its trading methods. So the fund wished to prevent our client using this IP in any new venture. Hence the LLP’s partners wanted indemnities and warranties from our client concerning his conduct prior to his departure from the LLP, i.e. that he had not disclosed any trading methods operated by the LLP.

Risk reduction

We gave our client the best chance of being paid and closed down the “wiggle room” to avoid non-payment. We closely reviewed the payment terms and ensured advance payments against the earn-out were paid into a joint client account, operating as an escrow. Hence, our client’s payments were ear marked.