British Venture Capital Group Warns Of Offshore Drift

by Robert Lee, Tax-News.com, London

14 September 2007

The British Venture Capital Association has warned that treating the carried interest earned by private equity partnerships as income rather than as capital would damage the UK's reputation as a place to do business, and could lead certain sections of the industry to move offshore.

In a briefing paper on the taxation of carried interest in the private equity industry, the BVCA concluded that the return generated by carried interest is an investment profit and should be taxed as such. The paper argued that carried interest should not be treated as ordinary income at higher rates of tax than at present, because it reflected the substantial amounts of investment made by private equity partnerships, and is an "appropriate return for the significant risk run by the executives".

"Individuals pay a fair price for their carried interest and, where an individual acquires an asset by reason of his employment, UK tax rules have always taxed any growth in value of that asset as an investment profit," the paper stated, adding that this is broadly in line with the way that carried interest is taxed in foreign jurisdictions.

UK Chancellor of the Exchequer, Alistair Darling is under pressure to change the capital gains tax rules to stop private equity firms benefiting from taper relief on carried interest. Business assets taper relief was introduced in 1998 as part of the reforms to the CGT system. In its original form, it reduced the CGT payable on business assets that were held for at least 10 years from 40% to 10%. In 2000, the period after which the maximum taper relief applied was reduced to five years, and it was reduced again in 2002 to two years. The original intention was to reward long-term investment, with a view to promoting enterprise, but critics of the system contend that it gives private equity funds and their partners an unfair tax advantage.

Trade unions and some UK legislators want carried interest to be taxed at ordinary income tax rates. However, the BVCA argues that a move to a tax system which treats this investment profit as a return on labour would be a departure from the traditional UK tax treatment of such investments. "It would be discriminatory against the industry and run the risk of creating anomalies and distortions," the paper stated. Moreover, the BVCA pointed out that individuals receive salaries and bonuses (or profit shares) for the services they provide and are fully taxed on that as income.

The paper went on to warn that any perception within the industry that it is being discriminated against would "severely damage" the UK’s reputation.

"The private equity industry is very mobile and highly attractive to a jurisdiction seeking to build or maintain a sophisticated financial services industry," the paper observed, going on to caution that: "Significant absolute tax increases would severely damage the UK’s reputation in the private equity world as a stable and attractive place to do business and cause parts of the industry (inevitably the larger less UK-centric parts which tend to be industry leaders) to base themselves offshore."

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