It will come as little consolation to Guy Hands, the financier who complained this week that he must be the last person in Britain still prepared to defend the private equity industry’s generous tax breaks. But I have a confession to make: I, too, am opposed to clobbering private equity funds — and if that makes us fellow champions of a lost cause, then so be it.
The current rather weird tax regime would admittedly never be chosen by someone redesigning it from scratch — but in the present climate, any change will succeed only in punishing one of Britain’s most successful industries while raising little or no revenue for the Exchequer. Trade unions’ calls for huge tax rises on the industry must be resisted.
Partners in private equity funds such as Permira or KKR often earn a 20 per cent cut of any profits from restructuring, turning around and reselling the businesses they buy out: their share of the swag is called ‘carry’ or ‘carried interest’. Because carried interest has always been treated by the taxman as an investment in an unlisted security, it is eligible for ‘taper relief’, which effectively reduces the tax rate paid by partners from 40 per cent to 10 per cent.
This generous capital gains tax regime applies to all business assets held for a long time. Alongside the granting of independence to the Bank of England, its introduction was one of Gordon Brown’s few genuinely enlightened policies. Because the main beneficiaries are in fact small entrepreneurs who sell their businesses, those now attacking private equity tend not to call for the tax break’s total abolition. Instead, they argue that in the case of private equity, ‘carry’ should be seen as investment income rather than capital gain, and hence taxable at 40 per cent; or that only the big funds should be stripped of this privilege and forced to pay a special super-tax. Both arguments are faulty.
Private equity partners invest large sums of their own money; while critics are right that much of it is often borrowed, it is still in their own names, and any loans funding it must eventually be repaid. Carry is only paid if private equity funds actually make money at the end of a long, complex investment; it is the profit-share that partners take home after paying out outside investors. There can be little doubt that it is legitimate to tax it as a capital gain, rather than as income.
When unions complain about private equity fat cats, they are really only talking about a tiny number of people. There are generally reckoned to be 18 major private equity companies in London, each with about ten partners who would be targeted for super-tax. So that makes 180 individuals, around two thirds of whom are thought to be foreigners registered as ‘non-domiciled’ and who therefore pay no tax. Of the British partners, roughly half are non-resident for tax purposes, so there are at best 30 members of this private equity super-elite who would be hit by a higher rate of tax — and many of them would respond by changing their tax status. In aggregate, the 180 superstars could actually end up paying less tax; the real losers would be partners in smaller funds, including those that provide seed money for start-ups.
The City has no God-given right to be Europe’s capital of finance; it is already suffering from serious leakage, camouflaged by the overall boom. There are now thousands of financiers based in Dubai, for example, including dozens of hedge funds that enjoy a zero-tax regime there; chunks of the London insurance market have moved to Bermuda for lower taxes; many back offices have relocated to Ireland. Private equity could be next. Already, many countries charge a lower tax on carried interest than Britain: across Europe, the tax ranges from zero to about 25 per cent.
Even Nicholas Ferguson, who as chairman of SVG Capital is one of the leaders of London’s private equity pack, recently argued that for highly paid executives in his industry to be paying ‘less tax than a cleaning lady’ can’t be right. It’s equally unfair that some people can work in Britain but pay no tax at all. But cranking taxes up to 40 per cent or more for all would be disastrous and would destroy the City’s competitiveness.
In the short term, the status quo is the least bad option. But over time the real answer is to slash tax rates for everyone, not increase it for a handful of talented financiers. To out oneself as a fan of private equity is, to say the least, unfashionable; it may be even more so to call for a single, low rate of tax, with no exceptions or exemptions for anyone. But only a flat tax can restore and entrench the City’s competitiveness while making the tax system more equitable. I for one am not losing hope: even the most hopeless of lost causes have a wonderful habit of eventually becoming the received wisdom.