UK carry tax: 18 percent

The clamor for a change in the UK private equity industry's tax treatment has been finally met with an answer. The UK Chancellor of the Exchequer Alistair Darling said in his pre-budget report he will increase the tax private equity executives pay on carried interest from 10 percent to 18 percent.

The Chancellor will scrap “taper relief,” which allows executives to pay 10 percent tax and he will instead introduce an 18 percent flat rate of tax in June 2008 on all capital gains in the UK. Private equity investments qualified for taper relief after two years prior to the change.

The tax relief became a focus for critics of the industry after Nicholas Ferguson, chairman of UK fund of funds SVG Capital said the regulations allowed highly paid private equity executives to pay “less tax than a cleaning lady” in April this year. Since this concession by a leading figure in the industry, a change had been widely assumed to be inevitable by buyout executives.

The former Chancellor and Prime Minister Gordon Brown introduced taper relief in his first budget in 1997. However, since Ferguson's comments, the tax has come under intense political scrutiny in the UK. It has become a rallying point for trade unions and hostile politicians against the relatively benign treatment of the industry by the government.

Many in private equity privately concede relief that this hostile climate had not led to a more severe change in the industry's tax treatment, which may have led to changes of up to 40 percent tax. Despite the relief, more vulnerable mid-market firms and venture capitalists are understandably reticent about the change.

Michael Trask, a tax partner at law firm SJ Berwin in London says the measures leave the tax in the “UK on the same rate as Spain on 18 percent without the weather.” It is important to note that the UK's chief European competitors in private equity Germany and France both have higher rates of tax on capital gains at 23.5 percent and 27 percent respectively and so it is unlikely firms will move overseas. If buyout firms meet certain strict criteria they can pay no tax in Switzerland on capital gains.

Trask says: “Will this move drive people abroad, my instinct is not. Zurich and Geneva are the big unknowns, but in my bones I believe people will not relocate there.”

Opinions differed on this crucial point, however. Richard Collier-Keywood, UK head of tax at accountants PricewaterhouseCoopers says: “It is disappointing that the Chancellor has increased the rate of tax on capital gains for business assets from 10 percent to 18 percent.

Whilst 18 percent is a competitive rate, there is a danger that this will drive some business overseas.”

Simon Walker, chief executive designate of trade body The British Private Equity & Venture Capital Association, also criticized the move. But this came as no surprise. The BVCA has consistently resisted any change, although as a lobbying group its warning of the potentially “dire consequences” of any change in its submission to the pre-budget report may have helped the UK government resist the temptation to punitively tax the buyout community.

The government has also moved to tax non-domiciled residents, which will apply to some private equity executives. “From April 2008 resident non-domiciles who have been in the UK for longer than seven of the part ten years will only be able to access remittance on tax after an annual charge of £30,000 [$61,000; €43,000],” the Chancellor said in the pre-budget report document.

Those who use this relief will no longer be entitled to income tax personal allowances and the rules will be amended to stop companies from sidestepping tax where it is due on foreign income and gains.

In a sign that private equity is on the cusp of entering the mainstream environment, Darling also welcomed “the private equity industry's resolve to become more transparent and the commissioning of Sir David Walker to develop a voluntary code to promote high standards of disclosure and valuation.” Hopefully this will set in place an effective monitoring framework with sufficient independence to command acceptance, he said.

In all, the industry will take a financial hit, but after the change it will be able to retain respectability.