Carry crisis in the making

The UK's status as a benign environment for private equity funds could be endangered by a change to carried interest rules. But how serious is the threat? By Andy Thomson

Any perceived challenge to the status quo regarding treatment of carried interest is bound to elicit strong emotions. In the UK, responses to just such an apparent danger have, unsurprisingly, been swift.

The furor blew up when the Sunday Times newspaper last month ran an article indicating that the Treasury, which formulates and implements the UK government's financial and economic policies, was considering re-classifying profits from carried interest (as well as those from the equity stakes held by portfolio company management teams) as normal income rather than capital gains. The newspaper's headline – ?Private equity bosses face tax disaster? – likely had more than a few private equity execs choking on their morning coffees.

To be fair, the implications could certainly be grave, amid predictions that taxation in these areas could potentially be hiked from 10 percent to as much as 40 percent. One understandable fear is that, under a more punitive regime such as this, quality individuals would be harder to attract to the private equity ranks. The reality is that, rather than suffer in silence, private equity firms would likely vote with their feet – by opting to be headquartered offshore rather than in the UK.

Ian Armitage, CEO of London-based mid-market private equity firm Hg Capital, made his opinions on the matter clear when rattling off a letter to the Daily Telegraph newspaper. In it, he said: ?If conditions become unattractive, especially the CGT regime, we should expect private equity firms to focus investment elsewhere and base their operations in more congenial jurisdictions.? Stirringly, he urged all in the industry to ?remain vigilant about threats.?

However, in an interview with sister website, Peter Linthwaite, CEO of industry body the British Venture Capital Association (BVCA), attempted to dampen down concerns. While clarifying that there had been ongoing correspondence with the Treasury about the taxation issue, he said the two organizations were in regular contact about ?all sorts of ongoing things? and that – for now at least – the issue should give no cause for alarm.

He stressed that, in his view, the private equity industry was not being singled out for special attention. Instead, the review into carry and management stakes forms just a small part of wide-ranging investigations into the taxation of employee share options under non-Inland Revenue approved arrangements stemming from Schedule 22 of the UK's Finance Act 2003.

Since the Act was drawn up, the UK private equity industry has been operating under a so-called Memorandum of Understanding (MOU) with the Treasury, which has preserved the benign CGT environment to date. But it has been widely reported by various media sources that the Treasury is now re-examining whether the continued application of the MOU is appropriate.

It is this re-examination that is both unsettling industry professionals and giving offshore jurisdictions optimism that a lot more funds business may soon be coming their way. An announcement from the Treasury to clarify the issue is expected later this year, according to the BVCA. The industry will await the outcome with bated breath.

FASB, IASB agree on harmonization
The US Financial Accounting Standards Board and the International Accounting Standards Board have published a memorandum of understanding that reaffirms a goal to develop common accounting standards for use in international capital markets. The move is designed to ?enhance the consistency, comparability and efficiency of financial statements, enabling global markets to move with less friction,? according to a joint statement. The announcement comes four years after the boards' Norwalk Agreement, which set forth a convergence work program. In the statement, Sir David Tweedie, chairman of the IASB, said the memorandum ?enables us to provide much-needed stability for companies using IFRSs in the near term, while taking advantage of a once-in-a-lifetime opportunity to contribute to removing the need for reconciliation requirements. Over the past year, representatives of the boards have held discussions with the European Commission and the SEC.

Korean regulators react to Icahn
A top South Korean regulator has said the country's financial authorities are pondering ways to tighten rules governing share tender offers in the wake of hostile takeover attempts from foreign entities. The news came as US ?activist? investor Carl Icahn pursues an unsolicited takeover offer for South Korea's largest tobacco company, KT&G. The rule change may involve requiring investors who wish to buy more than 25 percent of a company to buy 50 percent of the company, according to reports. Speaking to reporters, Kim Yong-hwan, an official at the Financial Supervisory Commission, said, ?As the hostile takeover has become a social issue, the government now feels the need to do something to help better protect companies, while complying with global standards.? The 50 percent requirement was removed following the Asian economic crisis of 1997/1998. Icahn, working in partnership with Steel Partners, recently had his offer to buy KT&G for $10 billion rejected by the tobacco company's board.

IT budgets set to grow across corporate America
A survey of 77 chief information officers across the US found that information technology budgets are set to grow by 3 percent this year. But factoring streamlined efficiencies and offshore outsourcing, the real expense increase on IT is set to expand by 13 percent, according to a survey from McKinsey & Co. The biggest spends are to be on security products, industry-specific extensions, servers and Sarbanes Oxley systems. The survey was conducted during the summer of 2005. Participants were selected from various industries but confined to US companies with more than $1 billion in revenues.

Australia eases media ownership rules
Last month, Australian regulators unveiled a media reform plan that will free up cross-media and foreign ownership laws in the country. The news has been greeted with interest by the growing roster of private equity firms active in Australia. Communications minister Helen Coonan proposed new rules that would allow a company to own a newspaper, two radio stations and a television station in one market. She also proposed doing away with all foreign ownership rules. Coonan recommended that the new rules be put in effect either in 2007 or 2010. According to reports, she added that ?material? foreign investment would still need the approval of the national treasury. In a Reuters report, Shaw Stockbroking analyst Greg Fraser said: ?Australia needs a level playing field in terms of investment and innovation so that broadband penetration and digital penetration generally can catch up with the rest of the world.?

Testing a friendship
At the recent British Venture Capital Association (BVCA) annual dinner in London, the organization's chairman Vince O'Brien revealed in a speech to members some key results from a survey of its members that will make unsettling reading for the UK government.

The survey found that only 19 percent of members gave the government a good rating for its policies on advancing the UK as an attractive place to do business. In addition there were clear concerns about regulations and tax. Half of members predicted that regulatory burdens would worsen compared with European competitors, while 57 percent believed levels of tax would increase.

Frustration with lawmakers provided a contrast with a general sense of optimism about economic prospects. More than two-thirds (69 percent) said the business climate has been favorable for them over the last three months and a similar number said they expected this to remain the case over the next quarter. Meanwhile, 68 percent said the UK was a more attractive place to do business than continental Europe.

In his speech, O'Brien insisted that the UK private equity industry ?has known no greater friend in the Treasury than the current Chancellor [Gordon Brown].? One wonders how strong the friendship will remain in the event of further legislative shocks to the system.