Chiltern Warns Over Attack On UK Private Equity Sector

by Robin Pilgrim, LawAndTax-News.com, London

30 May 2005

The publication on Thursday of the third Finance Bill of 2005, which reintroduces new tax rules that may severely restrict the amount of tax relief available on loan financing in leveraged buy out (“LBO”) transactions will have a significant impact on the private equity sector, according to professional services firm, Chiltern.

The new rules extend the existing transfer pricing rules to apply where parties act together to control and finance a business.

For example, in respect of loan interest paid to controlling collective investors, the new rules will deny a tax deduction for any element of the interest that is greater than an “arm's length” rate. Furthermore, in most situations, tax relief will now be delayed for interest paid late to controlling collective investors who are outside the scope of UK corporation tax.

Tax relief will now be available when the interest is paid, rather than when it is accrued, and the new rules will apply to new financing arrangements entered into on or after 4th March 2005. The new rules will also apply to pre-existing financing arrangements from the first date after 4 March 2005 on which the loan terms are changed, or from 1 April 2007, whichever is the earliest.

Andrew Shilling, Director of Chiltern’s M&A Tax Consultancy Practice, observed that:

“Although the Government has stated that the new rules are being introduced to tackle tax avoidance, in reality they represent a policy change to widen the tax base. The underlying issue is that the UK private equity industry has grown massively in recent years. The result has been a significant erosion in the corporate tax base due to large amounts of UK profits being legitimately sheltered from tax by loan interest paid to private equity investors."

He continued:

"The new rules are the Government’s dramatic response to this problem, and are likely to have a significant impact on the private equity sector, and may make some existing LBO deals uneconomic. Private equity groups should urgently restructure the terms of their debt onto an arm’s length basis in order to continue to enjoy a tax deduction for interest paid.”

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