Private grief
Nick Ferguson has big boots in the UK private equity industry: he is the creator of the business which mutated into Permira, the London-based private equity giant, and the chairman of , the leading subscriber to Permira鈥檚 funds.
As such, it is hard for private equity firms to dismiss him as a marginal character or someone with a prejudiced hostile attitude to their industry. So his remarks 鈥 as 鈥 will engender anxiety in the pricier rental districts of London鈥檚 West End where private equity firms are based.
Ferguson said: 鈥淎ny common sense person would say that a highly-paid private equity executive paying less tax than a cleaning lady or other low-paid workers... can鈥檛 be right.鈥
He was apparently referring to capital-gains-tax rules introduced by Gordon Brown as Chancellor which allow private equity executives to pay tax at a rate of just 10% on their share of the profits (known as the 鈥渃arry鈥) on a corporate buyout. 鈥淚 have not heard anyone give a clear explanation of why it is justified,鈥 said Mr Ferguson.
Well, one explanation might be that an industry valuable to the UK would emigrate to another financial centre without this tax break, to the detriment of growth and jobs here. But even if you think the presence in London of a substantial private equity industry is great for Britain 鈥 and there are plenty of people who don鈥檛 think that 鈥 it is moot that the industry would up sticks were the tax rate to be increased a bit.
In a world where it is fairly straightforward for highly remunerated executives to work in one place and live for tax purposes in another, there鈥檚 a painful rub for Her Majesty鈥檚 Revenue and Customs. One of the reasons why the private equity industry probably would not flee is that many of the leading private equity players at London-based firms don鈥檛 even pay the 10% tax, because they are not based here in terms of incurring a liability for personal taxation.
The risk for Gordon Brown and the Treasury in increasing tax on private equity is that many more private equity executives 鈥 large numbers of which are not British subjects 鈥 would find legal ways to avoid paying any tax at all: so even more of them might end up with a lighter tax burden than their office cleaners.
The debate about tax therefore is only half the debate. The central issue 鈥 the one being examined by the Treasury Select Committee 鈥 is whether private equity makes a positive or negative contribution to this country in a much wider sense.
I'm 
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Are there enough swanky restaurants in the Channel Islands? That would be the key question for any PE house looking to relocate.
Robert
Why is your focus as Business Editor at the 大象传媒 is almost always on the question of how much different groups are making? These are political questions in the end. what about covering some "business" topics that your political colleagues are not covering: like is the structure of the Reuters/Thompson deal good or bad for shareholders? Why is La Salle being valued by Bank of America and RBS as it is? What is the significance of the TNK/BP issue for the share price of BP? Is the Russian market properly valued? Which companies benefit most from the growth in India and China? what do you think of the proposed accounting treatment of Blackstone's carry? Do you think that Macquarie's cost of capital is as low as it appears to be?
These are subjects that the 大象传媒 is not covering anywhere. If not you then who covers them?
But it's not just the private equity execs that benefit from this 10% tax break, it's genuine entrepeneurs who risk their own money!
3.5 years ago 3 colleagues and I bought a business and invested considerable sums of our own personal cash (re-mortgaging house etc) to buy that business. We've run it hard for 3.5 years, working lots of late nights and weeks growing the business so that we now employ a good number of people. We pay corporation tax, rates, and emplyers NI, and our suppliers on time, and yes have to deal with loads of government red tape. In addition we've kept our own renumeration low compared to indsutry norms. So if at some point in time there was an exit option, and we realised a gain, why does the government deserve 40% - what have they done to help our business grow - sweet FA actually.
You'd have to question that if you only got 60% of any gain your might realise, perhaps you'd look to setup a business in another country that rewards entrepreneurship.
Looks like Leona Helmsley was speaking for private equity when she said
'We don't pay taxes. Only the little people pay taxes.'
and that was nearly 25 years ago...
There is a sensible way around this with a win/win potential...
One of the big problems I have with PE companies is that it has led to much smaller levels of funding for start-ups and spin-outs. The amounts of genuine risk equity capital seem to be going down in the UK rather than up.
So rather than tax PE companies higher the Govt should propose the opposite.. They'll keep their grubby hands off the PE companies and their employees provided they increase their investment levels in start-ups.
How about taxing companies which transfer work abroad? Not only do the British workers loose their jobs, the country looses the tax they would have paid. Why can't we encourage British firms to employ British people?
No wait a minute that would also penalise the government, who outsourced civil service work to American companies, who are now tranfering the work to cheap labour abroad! I wonder where the profit for the contract is going, America I bet.
Is it just me or . . . when a First World manufacturer moves to a Third World country, there is an immediate loss of jobs (and income, tax, etc) in the FW country. The workers in the new country of manufacture cannot afford to buy the product because of their low wages. The ex-workers cannot afford to buy the product, exported at some cost to the environment, so . . . who is going to buy it.
I'm no economist but I think some of our industry genii(!!) are very short sighted. Big profits now, but in twenty years!?!?
What about debt?
Closing tax loopholes which allow private equity firms to deprive public revenues of billions is important and necessary. There鈥檚 also no doubt that this is the most popular (and populist) measure that can be taken. But it鈥檚 far from adequate if governments are serious about reigning in the buyout funds. The main problem of leveraged buyouts by private equity funds is just that ... leverage. In a leveraged buyout a private equity fund usually provides just 10% to 20% of the equity as cash and the rest is borrowed. The assets of the company being acquired are put up as collateral to secure the debt and once taken over the target company (and not the private equity fund) must take this debt onto its accounts and meet the interest payments.
But the debt doesn鈥檛 stop there. Debt is also raised through "dividend recapitalizations" or "dividend recaps". This simply means that the company borrows money and the money borrowed is paid out to the private equity fund as a dividend. Here again we see a key difference with established notions of corporate accounting. Whereas dividends normally reflect a positive balance sheet, private equity uses debt to fund dividends and bonuses.
So here is where the debate on taxes needs to be taken further. While current tax proposals focus on 鈥渃arried interest鈥 (the percentage of profit, usually around 20%, that a private equity fund manager gets when an acquired company is sold off), less attention has been given to dividend recaps. Yet these dividend recaps now account for close to one-third of all income flows back to the new owners in the global private equity sector. More importantly, we need to ask whether taxes alone are enough of a deterrent. Billions in taxes may eventually be paid, but tens of billions of accumulating debt raises a whole new set of questions.