Odey Asset Management recently lost a dispute with HM Revenue & Customs that could have changed how other firms and companies pay executives for performance. The dispute dates back to the financial crisis, when the firm began to take on more people to create new funds and expand its existing ones, selling mainly to institutions. Since then, Odey funds have become more generally available through platforms such as Hargreaves Lansdown.
The firm told the tribunal that, until 2010, it had paid bonuses based on the profits generated in the previous year to its fund managers and traders in cash and in an ad-hoc way. As a result, the managers’ focus always tended to be on their current-year performance rather than the long-term success of the business. In a good year, the best performers might well receive over £1m, and there was little to stop them from then leaving. Odey’s executives realised that fund managers needed to invest some of their pay in their own funds because, according to the firm, it would create “a different dynamic” for them “when deciding whether the risk of an investment could be justified”. And having skin-in-the-game would help to encourage potential clients to invest in their fund.
But Odey is not a company so how could this be set up? Since 2002, it’s been a limited liability partnership, so there are no shares or shareholders. The partners own the firm and share a collective responsibility for what it does, but they have no individual responsibility for the actions of other partners. And, as with a shareholder in a limited company, they can’t lose more than they invest. When it comes to tax, distributions to the partners are taxed as if each individual is self-employed.
The advice from Odey’s auditing firm, EY, was to form a special purpose company, Partners Special Capital Limited (PSCL), to act as a notional partner. A proportion of the firm’s profits would then be paid into PSCL each year, to be invested in Odey funds. Each participant was advised of their profit allocation and that, as long as Odey had no need to claim back the capital over the next three years, they would then receive their allocation back from PSCL. If they left in the meantime, their allocation would be forfeited – not an idle threat, for the pressure on members to perform leads to high turnover rates.
There’s a parallel between these arrangements and those in FTSE companies, many of whom use an Employee Benefit Trust (rather than special vehicles) for a similar purpose. Typically, the company pays into the Trust when discretionary share awards are made so that the Trust can buy shares in the company. But, unlike PSCL, the Trust has to be truly independent, and it will never refund payments to its funding company.
Tax avoidance
In a typical discretionary company share plan, the Trust releases shares after three years to the participants. The number of shares released depends on performance conditions (if any), and although higher share prices will increase their value, such increases are not taxed as capital gains. Tax authorities interpret the moment when participants receive the shares as the point at which their pay materialises, so it’s all treated as income, from which income tax and national insurance contributions have to be deducted.
But that was not what Odey told its members. Odey had been advised that PSCL would pay corporation tax on the gain during the three years, and that members would then receive the residual amount tax free. Since at that time corporation tax was 28 per cent, and the highest rate of income tax together with national insurance contributions added up 51 per cent, this was quite a saving. Had this been upheld, consequences could have been far-reaching, so it’s hardly surprising that EY warned Odey that its advice about the capital transfer from PSCL with no gain or loss for the individual member “is based on HMRC statement of practice rather than unequivocal tax legislation”. For Odey, it was worth a gamble. Its managers had been reluctant to have their pay deferred for three years, and the sweetener of the tax break helped to clinch the deal.
EY had also warned Odey that the scheme might be challenged, but the firm was used to taking risks. Its funds sit at the speculative end of the investment spectrum: it shorts stocks to generate returns rather than to mitigate the risk of other investments, and the funds it manages have been known to gain or lose 20 per cent of their value in a month. The tax break was one risk that has not paid off, although not so much for Crispin Odey, who founded the firm in 1991. He declined to have his own pay deferred. So the ones expected to pick up the tab will be 17 of his current and former partners.
