The UK’s Inland Revenue has made what some view as an embarrassing climbdown on a tax change that could have forced leading private-equity players overseas.
The tax would have cost specialists such as Guy Hands and Ronald Cohen millions and could have driven them abroad. “If taxation were too high, it would stifle entrepreneurial activity and might result in private-equity houses moving abroad. You don’t have to work in the UK,” says Edmund Truell, chief executive of Duke Street Capital. “Wasting time on whizzo schemes, paying thousands to lawyers and accountants trying to minimize your tax – it is so unproductive.”
Will Schmidt of Advent International adds: “This tax could have put the UK at a competitive disadvantage and had serious implications for the location of private-equity funds. You could have seen a brain drain.”
The British Venture Capital Association lobbied the Inland Revenue to find a way round the changes, which became law when the Finance Act was passed in July. By July 25, the IR issued a statement clarifying the targets of the increased tax and, effectively, excluding private-equity executives from it.
Since 1987, the UK government has permitted a favourable tax treatment for senior executives of private-equity houses, ostensibly to encourage entrepreneurial activity. This treatment concerned carried interest – the profit that senior executives receive from the firm’s fund and which is their main form of remuneration. The executives invest only a nominal amount of their own money into their company’s fund, but receive carried interest on the profit made by the entire fund – which can run to millions of pounds.
This profit has been treated as a capital gain, attracting a tax of just 10%, and has made multi-millionaires of the top executives in the UK’s leading private-equity houses.
The tax changes could have ended all this. Although primarily aimed to address employee remuneration, in particular through shares and bonuses, the tax also stated that some carried interest would be treated as remuneration. So instead of the 10% capital gains tax, some carried interest could have been charged at 40% as income.
However, the July 25 statement said that carried interest would continue to be viewed as capital growth and taxed at 10%. “Our new statement will mean that carried interest is likely to be viewed as remuneration in only a very small number of venture capital funds, and in those funds to possibly only a limited extent,” says Paul Franklin of the IR.
The BVCA insists that the private-equity community was mistakenly caught up in a broader tax change aimed at employer incentives and shares. “They [the government] did not intend to catch us with this tax change. We are very pleased that, after very constructive discussions, we have come to a satisfactory resolution with the Inland Revenue,” says a spokesman for the BVCA.
But there has been speculation that the government was attempting to tap the millions of pounds that the private-equity financiers make. “It is possible that the government tried to push this through but, given the backlash and mounting pressure from the private-equity community, it may have backtracked,” says one banker.
Either way, the executives are mollified. But the controversy has shone a spotlight on the salaries of some of the country’s richest individuals.
These financiers have been lauding their entrepreneurial virtues to create a favourable impression with the IR. However, most firms are now so large that it is difficult to view them as venture capitalists.
This raises the question why they should receive such vast tax benefits. “The big private-equity houses are not really venture capitalists in the true sense any more. They have grown so much and are doing such big deals that they are more like conglomerates,” says David Slade, head of loans at CSFB.
