PRINT THIS PAGE Private equity taxation in the UK11/07/2007. Source: SJ Berwin. Jonathan Blake
In 1987, the British Government, conscious that Europe's nascent venture capital and private equity industry was developing offshore, decided that it wanted to attract fund managers to base themselves in London. So the Government (represented by a senior Minister - the Financial Secretary to the Treasury - and by the Department of Trade and Industry), sat down with the Inland Revenue (the UK's tax authority) and a team from the British Private Equity and Venture Capital Association (BVCA) (led by SJ Berwin's Jonathan Blake), to discuss how such funds ought to be taxed and regulated in the UK. Those discussions did not lead to any change in the law, nor did they create any loopholes. They just established how existing law would be applied to private equity and venture capital funds structured as limited partnerships. Limited partnerships are the most natural vehicles for these funds, and indeed are used by the Government itself on its own venture fund projects. But in 1987, clarity was needed because the UK's tax and legal rules had not previously been applied to such structures.
The statement, once agreed, was a public document - and for many years has been on the websites of both the UK tax authority and the BVCA. It dealt in detail with various aspects of limited partnership taxation, including carried interest - which was structured as a share of profits in the fund for commercial reasons, offering alignment of incentives between manager and investor. Carried interest - if and when paid over the ten year life of the fund - would, quite naturally, be a share of the underlying profits, including capital gain for tax purposes.
That was not a concession. It was just a fact. And, for the part that was a capital gain, normal rules would apply to calculate the amount chargeable to tax. The "base cost shift" - much discussed this week - simply refers to the fact that capital gains tax law in Britain works (in relation to partnerships) by allocating the acquisition cost of assets (as well as the disposal proceeds) to those who share the profits of them, and taxes the increase in value of those assets when sold (not, of course, the entire proceeds). In fact, the private equity industry did not seek this "shift". But the Government's position was clear: that is the way partnership tax law works, and it would be too difficult to re-write it.
The Government's decision to clarify the rules in 1987 turned out to be far sighted, and was undeniably one of the most important reasons that London became established as the leading centre for private equity activity in Europe - and remains so to this day. Since then, British companies have benefited from billions of pounds of investment that might not otherwise have been available to them, and British pension funds have enjoyed returns on their investments that have outstripped other asset classes.
Conscious of this success, successive Governments have deliberately - and openly - continued their dialogue with the private equity and venture capital industry ever since. So, for example, in 2003 new rules which were unclear in their application to private equity (and not intended to apply to it) were discussed and clarified.
That clarification said that the new rules did apply, but - provided that the funds work within some very clear parameters - the rules would mean that capital gains tax treatment would continue to apply to the longer term profit share that is the managers' deferred entitlement (as a founder partner) if the fund makes above market returns for investors. Incidentally, the rules have also always (since 1987) included a requirement that private equity executives are paid market salaries, on which they pay full income tax (at marginal tax rates of 41%).
These are not secret deals. They are not "loopholes". Private equity and venture capital funds pay tax at the rates set by successive Governments, and those Governments - rightly - have recognised that to charge carried interest (or other founder equity) to income tax would depart from an international consensus, and be hugely counter-productive. They have also recognised that certainty and clarity in tax law is a vital part of the attractiveness of an economy.
Governments do, and should, review tax laws on an ongoing basis. A review into the tax treatment of carried interest was launched last year, and is ongoing. It seems likely that the results of that review will be published later this year. As the debate rumbles on in the UK, there is no doubt that there will be strong political pressure for a change.
But the achievements of the Government in 1987, continued by those since, in nurturing a strong private equity industry for Britain (and Europe) should not be underestimated - or discarded lightly. Nor should the framework which has helped build London into the financial markets and private equity centre of the world be tampered with too easily, or without considerable pause for thought.
Jonathan Blake
SJ Berwin is a pan-European law firm with a particular focus on private equity. It has offices in London, Frankfurt, Munich, Berlin, Madrid, Paris and Brussels. If you would like further information on its services to the private equity industry please contact Jonathan Blake or Simon Witney in its London office +44 (0)20 7533 2222 or visit our website at www.sjberwin.com
|
