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Tax and private equity

• Robert Peston
• 15 Jun 07, 08:43 AM

There is something about private equity that really irks legislators (which is surely not old-fashioned envy about how much the partners of private equity firms trouser).

In the US, a pair of influential senators 鈥� the ranking Democrat and Republican on the Finance Committee, no less 鈥� are that would increase the tax paid by Blackstone, the private equity giant, after it floats on the stock market.

And in the UK, MPs on the Treasury select committee are s that they want private equity firms鈥� 鈥渃arry鈥� 鈥� their share of the capital gains made on the investments made by their funds 鈥� taxed at a higher rate than the prevailing 10%.

The Treasury now feels under irresistible pressure to reform this system in some way, following the admission made by two doyens of the private equity industry 鈥� and 鈥� to the effect that it鈥檚 hard to justify the tax rate for the really big players in private equity.

In fact, Ferguson may find himself commemorated in the annals of tax law, because any change in the private equity tax rate is being referred to as the Ferguson Premium.

Actually, I should point out that the partners in private equity firms in practice only pay 5% tax on the carry. That鈥檚 not because of a tax dodge, but because of age-old agreements with their investors about how the rewards and costs of investments are distributed.

Anyway there is a great deal of emotion around the place about how private equity billionaires pay less tax than cleaners, so it鈥檚 worth taking a deep breath and looking at the hard reality.

The big bucks in private equity accrue to the partners of around 18 London-based firms. They have raised around $115bn from investors 鈥� on which they personally stand to make hundreds of millions of dollars each.

There are about 180 of these partners in total. But of these, probably two-thirds are not British: they are super-bright foreigners who work in private equity in London, because it鈥檚 the European centre of private equity action.

Or to put it another way, 120 of the 180 private-equity partners are non-doms for tax purposes 鈥� so they pay ZERO tax in the UK.

The 5% carry-tax probably applies to the remuneration of perhaps 60 British people 鈥� except that 30 of these have probably become non-resident, basing themselves in Monaco or a similar tax haven for tax purposes.

On that basis, if the tax law was changed simply to catch the partners of the big private equity firms 鈥� which is what Sir Ronald Cohen suggests 鈥� it would have an impact on 30 people. And my guess is most of those would immediately take steps to relocate themselves abroad for tax purposes

In other words, a tax increase that was aimed merely at the super-rich end of the private equity market would probably be a complete waste of time, if its purpose were actually to raise revenue for the Exchequer.

Of course, the real point of any tax increase would be to feed the baying dogs of private-equity haters 鈥� even if the tax reform were innately fatuous.

However if a tax increase were applied more widely, to the couple of hundred smaller private equity firms whose partners don鈥檛 earn enough to relocate themselves abroad to escape tax, well that could 鈥� over time 鈥� shrink a valuable industry. The entrepreneurial partners in those firms might well go off and do other things, and the supply of investment capital to smaller companies would diminish.

The point is that in a globalised world, there are growing numbers of firms and individuals who can base themselves more or less anywhere for tax purposes 鈥� and therefore there is not a great deal that a country like the UK can do to extract much additional tax from them. It鈥檚 not fair, but it鈥檚 a fact.

Which means that the debate about private equity 鈥� which I鈥檝e said with tedious regularity 鈥� should be about whether its impact on the British economy is good or bad, in the widest sense. And if it makes sense to drive this large and successful British industry into the sea, then it would also make sense to tax private-equity partners till the pips squeak. But otherwise鈥�

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