UK Private Equity Industry Facing Tax Shake-Up

by Robert Lee, Tax-News.com, London

23 February 2006

It has emerged from reports in the British press that the UK Treasury is currently reviewing the taxation of management incentives in the private equity industry, sparking fears that the government may be seeking to extract more revenues from the multi-billion pound industry.

According to a report in the Financial Times, the British Venture Capital Association has been holding talks with the Treasury this week to discuss issues surrounding the Budget, which is due next month, and plans to discuss the issue of taxation at a later date.

However, it has also been reported that the HM Revenue and Customs is already working on draft proposals to change the tax regime for venture capitalists which are expected to be published in May. These proposals will then be put out to consultation.

It is believed that HMRC is examining whether management teams should pay more tax on any gains they make on the stakes they acquire when they lead buyouts.

The Revenue is also considering increasing tax on 'carried interest,' or the share of the profits that private-equity fund managers take from an individual investment, which typically amounts to 20% of the profit on a deal.

At present, carried interest attracts a tax rate of 10%. Some industry insiders predict that the Treasury will raise this by 5% to 8%, although it is said that the Revenue has considered taxing these profits at as much as 40% - a "worst case scenario" that the industry will be keen to avert.

Currently, the tax regime for management equity and carried interest is governed by two 'memoranda of understanding', agreed between the tax department and the industry some years ago.

Private equity professionals earn an estimated GBP2 billion annually from carried interest so any move to increase taxation could result in the Treasury collecting several hundred million pounds in extra revenues.

However, the venture capital industry is likely to argue that an increase in tax on carried interest could spark an exodus of private equity firms offshore. Moreover, it is estimated that 20% of the UK's private sector workforce is employed by companies owned by private equity firms.

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