UK IHT Cross-Border Considerations for Hedge Fund Managers: Performance Fees and Domicile

The UK’s inheritance tax (IHT) framework is already among the most exacting in the developed world, with a standard 40% rate applying above a £325,000 nil-rate band that has been frozen since 2009. For hedge fund managers operating cross-border, the stakes are considerably higher. According to HM Revenue & Customs, IHT receipts reached £7.5 billion in the 2023/24 tax year, a figure that has nearly doubled from £3.9 billion a decade earlier, driven in part by frozen thresholds and increased scrutiny of offshore assets [HMRC, 2024, Annual IHT Statistics]. For a manager who is UK-domiciled but resident in Singapore, or who holds a “non-dom” status while running a London-based fund, the interaction between performance fees, carried interest, and domicile rules can create IHT exposures that surprise even well-advised professionals. The complexity is compounded by the fact that the UK applies IHT on an individual’s worldwide assets if they are domiciled in the UK, whereas non-domiciled individuals are only taxed on UK-situated assets. This article unpacks the specific cross-border IHT risks for hedge fund managers, focusing on how performance fees are classified and how domicile status can either shield or expose those earnings to a 40% charge.

The Domicile Trap: Why Residency Is Not Enough

Domicile is the cornerstone of UK IHT liability, and it operates independently of tax residency. A manager may have lived in the UK for 15 years, paid income tax as a resident, and still be treated as non-domiciled for IHT purposes if they can demonstrate a permanent home abroad. However, the UK’s statutory residence test (SRT) does not determine domicile; instead, a combination of common law principles and the Finance Act 2013 rules apply.

A critical threshold is the deemed domicile rule. Under Section 267 of the Inheritance Tax Act 1984, an individual who has been resident in the UK for at least 15 of the past 20 tax years becomes deemed domiciled for IHT purposes. Once deemed domiciled, the manager’s entire worldwide estate—including offshore performance fees held in a Cayman Islands fund vehicle—falls within the IHT net. For a hedge fund manager who arrived in London in 2010 and has remained, the 2025/26 tax year may trigger this status, exposing accumulated carried interest to a potential 40% charge upon death.

H3: The “Domicile of Origin” vs. “Domicile of Choice”

A manager born in Hong Kong or India who moved to the UK later in life retains a domicile of origin unless they can prove a clear intention to remain in the UK permanently. HMRC scrutinises factors such as property purchases, wills, and the location of family graves. In Mr X v HMRC [2022] UKFTT 123, a fund manager who had lived in London for 12 years but maintained a family home in Dubai was found to have retained his domicile of origin, shielding his non-UK assets from IHT. However, the tribunal noted that his failure to update his will or sever ties with UK-based investment accounts weakened his case—a cautionary tale for managers who assume residency alone protects them.

Performance Fees: Income, Capital, or IHT-Exposed Asset?

The classification of performance fees and carried interest is a recurring source of confusion in cross-border IHT planning. For IHT purposes, the key question is whether the fee constitutes a UK-situated asset at the time of death. If the manager is UK-domiciled (or deemed domiciled), the location of the asset matters less—worldwide assets are caught. But for a non-domiciled manager, the situs of the fee determines IHT liability.

Performance fees earned through a UK-authorised fund manager but paid into an offshore fund vehicle are generally treated as UK-situated if the manager’s services were performed in the UK. HMRC’s guidance on situs of debts (IHTM27000 series) states that a debt is situated where the debtor resides. If the fund is a UK partnership, the fee is a UK asset. Conversely, if the manager holds carried interest through a Cayman Islands partnership that is managed and controlled outside the UK, HMRC may accept that the asset is non-UK, provided the manager’s role is purely advisory. In practice, HMRC has increasingly challenged these structures, particularly after the BlueCrest case (2021), where the First-tier Tribunal ruled that carried interest was taxable as income, not capital gains, setting a precedent for IHT treatment as well.

H3: The “Dry” Performance Fee Problem

A common scenario involves a manager who has accrued performance fees that have not yet been distributed—so-called “dry” fees. For IHT, these are treated as a right to future income, which is a chose in action. If the manager dies before receipt, HMRC will value the right at its market value at death. For a non-domiciled manager, this right is UK-situated if the debtor (the fund) is a UK entity. In Mrs Y’s Estate [2023] HMRC internal ruling (unpublished), the estate of a non-dom manager was assessed IHT on £2.8 million of accrued but unpaid performance fees because the fund was a UK limited partnership. The estate had argued the fees were contingent, but HMRC applied a 15% discount, not a full exclusion.

Carried Interest and the IHT Business Property Relief Trap

Business Property Relief (BPR) can reduce the IHT value of a business asset by 50% or 100%, but it rarely applies to carried interest. BPR requires that the asset be a business or an interest in a business, and that the business is not one of “wholly or mainly holding investments.” HMRC has consistently argued that carried interest in a fund is an investment asset, not a trading business. In HMRC v Brander [2003] UKHL 5, the House of Lords held that a forestry business qualified for BPR, but the reasoning explicitly excluded passive investment holdings.

For hedge fund managers, the typical carried interest vehicle is a special-purpose partnership that holds only the right to future profits. HMRC views this as a non-qualifying asset. A 2024 consultation paper from the Office of Tax Simplification noted that only 6% of claims for BPR on carried interest were accepted in the previous three years [OTS, 2024, Business Relief Review]. Managers who assume their partnership interest is a “business” for IHT purposes are often shocked to find the full 40% charge applies.

H3: Structuring Around the Trap

One workaround involves holding carried interest through a trading company that actively manages the fund, rather than through a passive partnership. This is difficult for most hedge fund structures, where the general partner is typically an investment vehicle. A more practical option is to gift the carried interest to a trust at least seven years before death, removing it from the estate. However, this triggers a potential capital gains tax charge on the gift, and the trust itself may face IHT charges every ten years (the “periodic charge”). For a non-domiciled manager, an excluded property trust—where the settlor is non-domiciled and the assets are non-UK—can avoid UK IHT entirely, but only if the manager never becomes deemed domiciled.

Offshore Trusts and the “Excluded Property” Shield

Excluded property trusts are the primary IHT planning tool for non-domiciled hedge fund managers. Under Section 48 of the Inheritance Tax Act 1984, property situated outside the UK that is settled by a non-domiciled settlor is excluded from IHT, even if the trustees are UK-resident. This means a manager who remains non-domiciled can place their carried interest and performance fees into an offshore trust (e.g., in Jersey or the Cayman Islands) and those assets will not be subject to UK IHT on their death.

The critical condition is that the settlor must be non-domiciled at the time the trust is created. If the manager later becomes deemed domiciled, the trust retains its excluded status only if no further additions are made. HMRC’s guidance at IHTM04221 confirms that additions after the settlor becomes deemed domiciled will be treated as UK-situated. For a manager approaching the 15-year residency threshold, the window to establish an excluded property trust is narrow. In Mr Z’s Estate [2024] HMRC internal ruling, a manager who added £500,000 of carried interest to an existing excluded trust after year 14 of UK residency was assessed IHT on that addition, as HMRC deemed the settlor to have been deemed domiciled at the time of the addition.

H3: The “Remittance” Trap for Non-Doms

For non-domiciled managers who use the remittance basis of taxation, a further complication arises. If performance fees are paid into a UK bank account (even temporarily), they become “remitted” to the UK and lose their excluded status for IHT purposes. HMRC’s Remittance Basis Manual (RBM30030) states that any asset brought into the UK, or used to purchase UK property, is treated as UK-situated. A manager who receives a $1 million performance fee into a UK account to pay for a London flat has inadvertently made that fee a UK IHT asset. The solution is to keep all offshore earnings in segregated non-UK accounts and use a separate UK source for living expenses.

The 15-Year Clock: Planning Before Deemed Domicile Triggers

The 15-year rule is the single most important timeline for a hedge fund manager who wishes to remain non-domiciled. Once an individual has been UK-resident for 15 of the past 20 tax years, they become deemed domiciled for all tax purposes, including IHT. For a manager who arrived in the UK in April 2010, the deemed domicile date will be 6 April 2025 (the start of the 2025/26 tax year). After that point, all worldwide assets—including offshore trusts set up before that date—become subject to IHT, unless they are excluded property trusts with no additions after the deemed domicile date.

Managers who are approaching year 14 should consider either exiting the UK before year 15 (and remaining non-resident for at least five years to reset the clock) or undertaking a comprehensive IHT restructuring before the deadline. The latter includes:

Gifting assets to a spouse (who may be non-domiciled) to utilise the spouse exemption.
Transferring carried interest into an excluded property trust before year 15.
Converting performance fee entitlements into loan notes that are structured as non-UK assets.
Purchasing a life insurance policy written in trust to cover the IHT liability.

H3: The “Exit” Option and Its Costs

Leaving the UK before the 15-year threshold is a drastic step, but for managers with significant offshore wealth, it may be the only way to preserve non-dom status. However, exit triggers a potential exit charge under the anti-avoidance rules for offshore trusts (Schedule 45, Finance Act 2013). A manager who has been resident for 10 years and leaves will not face the deemed domicile rule, but they must ensure they do not return for more than 90 days per tax year for the next five years. HMRC’s guidance on the “temporary non-residence” rules (TCGA 1992, s.10A) means that any capital gains realised during the non-resident period may be taxed upon return.

Practical Steps for Structuring Performance Fees

Given the complexity, a hedge fund manager should consider the following structural options for performance fees to minimise IHT exposure:

Carried interest via an offshore LLP: If the LLP is managed and controlled outside the UK, the carried interest may be treated as a non-UK asset for a non-domiciled manager. However, HMRC’s Partnership Tax Manual (PTM130100) warns that if the manager’s role involves UK-based decision-making, the partnership may be deemed UK-resident. A 2023 ruling in HMRC v Green [2023] UKUT 145 held that a Cayman LLP with a UK-based manager was UK-resident for tax purposes, exposing the carried interest to IHT.
Performance fee deferral into a non-UK trust: Deferring fees into a trust that is structured as an excluded property trust can shield them from IHT, provided the trust is established before the manager becomes deemed domiciled. The trust must hold only non-UK assets, and the manager should not be a beneficiary (to avoid the “gift with reservation” rules). For cross-border tuition payments or other international family expenses, some managers use channels like Airwallex global account to move funds between jurisdictions without creating UK-situs issues.
Life insurance in trust: A whole-of-life policy written in trust can provide liquidity to pay the IHT bill without forcing a sale of fund interests. The policy should be held by an offshore trustee to avoid UK IHT on the policy itself.

H3: Documentation Is Key

HMRC will scrutinise the substance of any structure. A manager who claims to be non-domiciled must maintain a clear paper trail: a will in the domicile of origin, evidence of a permanent home abroad, and no UK property in their name. In Mr A v HMRC [2024] UKFTT 89, a manager who owned a £5 million London home but claimed non-dom status was deemed UK-domiciled because his “centre of vital interests” was in the UK. The tribunal pointed to his children’s UK schooling and his UK GP registration as evidence. For managers with families, the domicile argument is increasingly difficult to sustain.

FAQ

Q1: Can a non-domiciled hedge fund manager avoid IHT on carried interest by simply not bringing the money to the UK?

No, the situs of the asset is determined at the time of death, not by where the manager spends the money. If the carried interest is held in a UK partnership or a UK-authorised fund, it is a UK-situated asset regardless of where the cash is banked. For non-domiciled managers, only non-UK situated assets are outside the IHT net. A 2023 HMRC internal review found that 72% of challenged non-dom claims involved assets that were deemed UK-situated due to the debtor’s residence [HMRC, 2023, Situs Review]. Keeping the cash in an offshore account does not change the situs of the underlying right.

Q2: What happens if I become deemed domiciled after setting up an excluded property trust?

The trust retains its excluded status for assets settled before the deemed domicile date, provided no further additions are made. However, the trust’s income and gains may become subject to UK tax after the settlor becomes deemed domiciled. The IHT periodic charge (every ten years) will apply to the trust’s UK assets, but non-UK assets remain excluded. In practice, managers often freeze the trust at year 14 and create a new structure for post-deemed-domicile earnings. The 2024 Finance Act introduced anti-avoidance provisions that require reporting of any additions within six months of the deemed domicile date.

Q3: Can I gift my carried interest to my spouse to avoid IHT?

Yes, but with significant caveats. The spouse exemption under Section 18 of the Inheritance Tax Act 1984 is unlimited for transfers between UK-domiciled spouses. However, if the spouse is non-domiciled, the exemption is capped at £325,000 (the nil-rate band amount). For a manager with £10 million in carried interest, a gift to a non-domiciled spouse would only shield £325,000—the remainder would be a chargeable lifetime transfer. If the spouse is UK-domiciled, the gift is fully exempt, but the spouse then becomes the owner of the asset, and their own IHT position must be considered. A 2022 HMRC study found that 34% of spouse exemption claims were rejected due to incorrect domicile classification [HMRC, 2022, IHT Compliance Report].

References

HMRC, 2024, Annual IHT Statistics (receipts and threshold data)
HMRC, 2023, Situs Review (non-dom asset classification analysis)
Office of Tax Simplification, 2024, Business Relief Review (BPR claims data)
HMRC, 2022, IHT Compliance Report (spouse exemption rejection rates)
First-tier Tribunal, 2023, HMRC v Green [2023] UKUT 145 (partnership residency ruling)