Renewable energy tycoon Dale Vince is not just battling for a greener Britain. The eco-warrior is also putting the wind up Mayfair’s buyout barons. He is seeking a judicial review of the tax authority’s approach to the private equity sector. A tax loophole agreed in 1987 amounts to a gift to some of the country’s wealthiest, he says.
The generous tax treatment of carried interest, the fund managers’ cut of profits from asset sales, has long been controversial. In 2007, one revealed they paid lower tax rates than a cleaner. The rate has since risen to 28 per cent. Even so, it is less than two-thirds of the top marginal income tax rate.
The logic behind the discrepancy is that carried interest should be taxed as capital. It is a return on the investment that managers are required to make in their own fund.
Yet there are several objections. First, the amount managers invest is small compared to their share of returns and often funded through non-recourse loans. Second, the industry is dominated by leverage buyout funds. Tax expert Dan Neidle argues their buy-improve-sell-repeat activity is really trading, not investment. Third, and most divisively, critics see some aspects of private equity as socially useless.
The Labour party swiped at “asset strippers” when it announced its plan to axe the carried interest loophole in the hope of raising £440mn of tax. More recently, it has stressed private capital’s role in generating growth.
The judicial review, if successful, would affect more than just the fund managers. Pension funds and charities’ tax exemptions cover investment activities but not profits from trading. Hence, they might be taxed on their private equity investments were they deemed to be trading.
A broader counter objection is that private equity funds might decamp to more hospitable locations. France, Italy and Spain are among those that offer lower rates than the UK. An exodus would undermine the reform’s revenue-raising potential. City law firm Macfarlanes, which is close to the buyout industry, estimates that if 150 of the top dealmakers left, the UK would lose £269mn in tax.
The broader ramifications of a change in tax treatment cannot be properly assessed in a judicial review. There is a decent case for reform. But it should be undertaken by legislators, after a careful review.
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