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Tax torpor

A number of key tax issues facing UK private equity firms appear to have been left unresolved in the run-up to the next Budget.

With most of the UK private equity industry probably still digesting the government's weighty Pre-Budget Report (PBR), one leading financial services firm wasted no time in proclaiming that private equity funds had good reason to feel disappointed.

The PBR, which Chancellor Gordon Brown delivered on December 6, provides an indication of proposals that are being considered for inclusion in the Budget the following March. According to Grant Thornton, an adviser to mid-corporate businesses, this year's PBR was a missed opportunity to clear up some outstanding tax issues.

Stephen Quest, head of tax transactions at Grant Thornton, said: ?The taxation of private equity funds has been in a state of flux for the last two years. The market needs stability to enable deals to be completed with a degree of certainty. Clarity in this area would have provided a boost to the private equity sector, which has brought so much to the British economy over the last year.?

Arguably the darkest tax cloud hanging over the heads of UK private equity professionals is the retrospective application of transfer pricing regulations to the financing of investee companies. From April 2007, consideration paid to private equity funds in respect of finance deemed not to be available on an arm's length basis may not qualify for deduction of corporation tax relief.

It has been estimated that the new rules can increase the cost of finance by 3 to 5 percent for portfolio companies despite the fact that, at the time the finance was put in place, no such legislation existed. Quest said: ?We had hoped to see a pre-Budget in which the Chancellor put this right. His failure to do so will result in private equity funds taking a hit in April. It also sets a dangerous precedent and undermines the basis upon which funds will make investment decisions in the future.?

Grant Thornton also drew attention to tax issues still awaiting clarification in other areas, among them:

Ratchets: In August 2006, Her Majesty's Revenue and Customs (HMRC) confirmed that a proposed British Venture Capital Association (BVCA) safe harbour would apply to the tax treatment of ratchets in which management teams acquire ?sweet equity?. Here, the use of loans means that only a small proportion of the cost of a deal pays for the equity, which generates a big return for investors if things go well. However, this only applies where the manager invests at the same time as the fund. The PBR did not address the still thorny issue of post-acquisition changes to ratchets which cause problems when private equity investments are refi-nanced.

Earn-outs: The number of deals being structured with an earn-out element is increasing. However, in the view of Quest: ?The tax law in this area is a considerable mess with uncertainty as to whether future receipts are taxed on a current or deferred basis. There is urgent need for reform in this area.?

Carried interest: Whether capital gains tax taper relief applies in respect of carried interest has long been unclear but is a vital issue given that it can make the difference between a 10 percent and 41 percent tax charge. HMRC currently takes the view that until the carried interest hurdle is met, partners do not have any entitlement to the underlying securities and, therefore, no taper can accrue. This means that, on exit, capital gains tax is payable in full by each of the partners at 40 percent rather than the lowest effective rate of 10 percent.

Given the existence of issues such as those outlined above, Quest's view is the UK tax regime for private equity funds leaves a lot to be desired: ?Private equity?deserves a fiscal regime that is consistently applied and delivers certainty to the funds in assessing investment opportunities in the UK. It remains the case that there is significant uncertainty and this is disrupting the flow of funds into the UK market.?

The BVCA, which maintains an ongoing dialogue with HMRC regarding tax and other issues, was rather more measured in its response. A statement from its chief executive Peter Linthwaite, said: ?We look forward to continuing the dialogue with the Chancellor about how we keep London and the UK as the centre of the European private equity and venture capital industry.?

Asian private equity firm joins AIM to boost visibility
Origo Sino-India, a Beijing-based investment and consultancy business, will float 25.7 million shares, representing 40 percent of the company for an expected price of £10 million (€15 million; $20 million). The company recently raised £11.8 million from investors and is expected to have a market capitalization of £32.6 million on admission. Origo will list ordinary shares at 50p a share and warrants to subscribe for ordinary shares at 55p a share, which are exercisable over three years, according to a statement. Following the initial public offering, Origo will have a market capitalization of £33 million and Chris Rynning, chief executive officer of Origo, will remain the largest single shareholder with a 20 percent stake, which is worth £6.5 million. Rynning told sister news service PrivateEquityOnline: ?We wanted to create liquidity for our shareholders. It's also a credibility issue for us. For us to have walked up the path to take an India and China focused company public in London lends us credibility and visibility. This contributes to increased deal flow and we're attracting interest from Europe and the US.? Rynning also said the motivation behind the initial public offering was to improve the company's image to potential employees.

Tennenbaum deal deemed good faith
Los Angeles private equity firm Tennenbaum Capital Partners won a victory in late November when the US Bankruptcy Court for the District of Delaware ruled Tennenbaum had not ?schemed? to acquire a portfolio company in a ?loan-to-own? strategy. The case arose from Tennenbaum's acquisition of Radnor Holdings Corporation. Tennenbaum was the largest owner of Radnor's senior debt before the company filed for Chapter 11, after which the private equity firm came to be a stalking horse bidder for the company. Tennenbaum eventually purchased Radnor for $224 million. Radnor's official committee of unsecured creditors filed a complaint against the investment firm claiming recharacterization, equitable subordination and breach of fiduciary duties. The other creditors claimed Tennenbaum conspired to benefit itself at the expense of the unsecured creditors. The court sided with Tennenbaum on all counts and the transaction was approved.

NASDAQ's new ambassador
NASDAQ announced the appointment of Robert McCooey Jr. to the role of senior vice president of a new unit within NASDAQ known as the Capital Markets Group. McCooey joins the team from The Griswold Company, the NYSE floor broker he founded in 1988, where he served as the firm's president and CEO. The new Capital Markets Group was formed to serve as a centralized unit to coordinate the company's outreach to private equity firms, investment banks and institutional investors. In his new role, McCooey will insure that the three constituencies are better informed on relevant issues, initiatives and services at NASDAQ that can support their business and growth plans. While with Griswold, he served in several capacities at the New York Stock Exchange that will no doubt inform his new position. McCooey served on the NYSE Group's Market Performance committee and was chairman of the NYSE's Technology and Planning Oversight committee. In addition, he has served on the Board of the NYSE Foundation, which he joined in 2003; the board of Securities Industry Automation Corporation (SIAC), the technology subsidiary of the New York Stock Exchange and the American Stock Exchange; and on the Committee for Review, part of NYSE regulation. He also served on the NYSE Board of Executives from 2003 to 2006 and was a NYSE floor official for eight terms.