Tax and private equity
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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Most people seem utterly ignorant of the idea that if you raise tax levels, you might not actually increase the amount of tax receipts coming in, due to scenarios such as these.
You misunderstand politicians. They are only concerned with being seen to be doing something.
Absolutely, buying established companies for 拢100m + is completely different risk proposition from backing the next Skype or Google start up.
It seems only fair that the lower risk deals should attract a higher (than 10% at least) rate of tax...
Capital gains are taxed at a low rate to encourage people to take risk which is why capital losses are also taken into account to offset gains. The point about the carried interest or 'the carry' is that no money has been risked in acquiring it. It is a right to profit participation if there is a profit but the downside isn't a loss, it is simply that there is no profit. This looks and feels like income and should be taxed as such.
The politicians may not be able to do anything about the tax issue, but they can enforce more accountability and open access upon the private equity firms.
Given how little benefit accrues to the average taxpayer in london from private equity deals, the fact that these superrich people will relocate elsewhere is just fine, then maybe they will stop buying second and third homes and stop driving up costs for the rest of us who actually do pay our way with taxes at 40%. If 120 of the 180 partners are non domicile then there must be a huge outflow of capital from the UK abroad which again does absolutely nothing for our eceonomy, yet the private equity business adds millions to the nation's unemployment payments and pensions deficits. It is time to redess the balance. If Peston thinks nothing can be done, he needs to get out more and broaden his horizons.
I like to buy counter argument that we should not force these entrepreneurs to pay more tax as it could discourage them to take risk and bail out sick companies from doom. however, to make thing transparent we should have strict regulations around so we should not have another Enron, black Friday, south east debacle or dot com bust.
I wonder if your readers understand that the carry in a private equity deal is not a salary? It will only arise if the equity investment that the Private equity firm makes on behalf of its investors grows by more than a hurdle rate (say 12% per annum: the hurdle rate is usually set at the market so the PE firm must beat the market over a number of years before it can earn the carry. the carry is then sometimes set at 20% of the excess capital gain. beating the market in this way is what only a few fund managers do. To do so the private equity firm must be able to create value. That is really no different from a person starting up from scratch and building a successful business. so contrary to what you say, its perfectly fair to treat PE carry in the same way as capital gains in the economy more generally
I have a better idea: cut the main rate of business tax to match.
Not all carry gets taxed at 10%, let alone 5%.
The 10% rate was brought in for all entrepreneurs to encourage them to take risk. A carry only pays out if performance exceeds quite high hurdle rates.
Not only that, but the conditions for the carry to be treated as capital were set out in the Memorandum of Understanding with the BVCA about not being substitutions for earnings, that they are subscribed for at a time when they are worthless / at market value, that there aren't preferential rates of return for them as opposed to other investors, that the deal is structured in particular, approved ways,
It is actually very difficult to get within the 10% rate.
Nor is it clear how the taxation of PE could be altered, when it forms part of the general thrust of government policy on the taxation of share rewards.
The discussion sounds so as in th 1970's when Labour managed to tax out the high earners from the UK. This resulted in a "brain drain" and also the loss of the pull of money to come to England. Hedge Funds & Buy-out companies require funds for their aims, this results into money being paid into company accounts which in the end result into "cheap money" for the whole market benefiting all. Until this money is used in a "purchase" it remains in an account with low interest, this pull of funds to London due to the high level of such investment companies benefits the UK in whole.
The aim to tax high income earners will result into an outflow of such companies and people bring back high interest rates [=high mortgage rates], high unemployment and a reinactment of the 70's.
I agree. All those who lambast the industry for employing one in every five private sector employees should bear in mind that it does employ one in every five private sector employees and is thus a formidable force in our economy.
The private equity industry is a jewel in London's crown and the tax breaks the government affords the industry are the very reason it contributes so well to the UK economy.
Don't tax them yet.. Ask them to make considerably more risk equity capital available for start-ups and spin-outs. If they don't then tax them.
William - please define the contribution of PE to the UK economy. As far as I can tell the industry has absolutely no impact on real economic growth simply because it's not creating anything new.
We should appreciate that politicians want to do something about it, but probably taxing more _only_ would help like a massage to a wooden leg. What we need is a change of mentality, large profits are obscene and those who make it should be ashamed rather than boasting about it (the same bad culture like boasting about how much we can drink!). And don't tell me about reward for taking risk. Taking big risk should be discouraged because when it works it mostly benefit the risk taker and most of the time, when it doesn't, many innocent people suffer because of that.
Whether these guys pay tax or not is not the issue. The issue is that the tax system should be fair and equitable. British CEOs should not be able to fly in and out of the country on Tuesdays and Thursdays each week to avoid residency status and get tax relief. Foreign residents (like myself) should not be able to avoid taxes that ordinary british people have to pay on offshore income. Private Equity bosses and HF managers should not be alowed to pay themselves offshore or at discounted tax rates via accounting loopholes. If the system is not fair for everyone you will eventually breed discontent (im shocked it hasnt already). British people should not live at a tax disadvantage to foreigners in their own country; its fundamentally wrong
The tax paid by a tiny number of individuals isn't really the issue here.
The real issue is surely that private equity uses debt to replace conventional quoted equity capital.
But, unlike the payment of dividends to equity shareholders, interest on this debt is tax-deductible.
This isn't a level playing field. It gives private equity an unfair advantage over quoted companies, and does so at the taxpayer's expense.
So the real solution is to remove tax relief on the interest on acquisition debt.
I used to work in IT and until the government killed the industry by increasing the number work permits issued under the HSMP and introduced tax laws such as IR35 and more recently the closure of composite companies, I had a very nice income. However nothing last for ever, I therefore decided to retrain as a barrister. My point is this : cough up your fair share of tax like everybody else had to and if you dont like it seek alternative employment. VC is no different and does not deserve special treatment, lets face it - Does VC really add value, look at the Rover farce for all that is bad. IMHO VC creates very little apart from the people at the top of the pile.
"A tax is a fine on success. A fine is a tax on failure."
Private equity magnates are unlikely to spend their entire wealth on wardrobes for their WAGs. (Yes, they may have private jets, but unlike footballers and rap stars, they're generally satisfied with just the one.) They're also unlikely to leave it on deposit (since, as you say, they are exceptionally bright people). In other words, all that income is going to be promptly re-invested elsewhere.
Now, if you give 拢10m to a private equity magnate to invest, and another 拢10m to a civili servant, which of them is going to invest it in a way which creates more jobs and more wealth for the economy at large?
> 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.
That view is too inward looking. The
debate must be about whether the
impact on Britain itself is good or
bad. The economy is one component in
that discussion, but higher goals
exist, such as national cohesion,
which is under threat at this time.
To do well, Britain has to heal the
wounds inflicted by all the greed of
the last few decades.
I鈥檝e got nothing against a few tax
dodgers/fiddlers/twisters (whatever
you want to call them) but if we want
to be able look back at British
history with pride, we might have to
pay the price and drive them out to
lesser countries with lower standards
of decency and fair play (or perhaps
we don鈥檛 need that in England
nowadays?)
The tax system, like the 大象传媒, must be impartial. If these guys have found a little hole, plug it and move on.
Next problem?
Shouldn't the tax treatment of all businesses be equal. We shouldn't be tinkering with the tax system to encourage certain types of business or to discourage other types because the market will only respond by exploiting loopholes. All businesses should be taxed at the same rate and then the business structure adopted would be that best suited to the business rather than that best suited to the tax regime.
> Most people seem utterly ignorant
> of the idea that if you raise tax
> levels, you might not actually
> increase the amount of tax receipts
> coming in.
Tories would advocate raising taxes in
order to lower them, if you are right. For
example, if we make taxes 100%,
nothing at all would come in,
and both the hard left and hard right
would be ecstatically happy!
But the important thing for
the morale of the nation is that the
toffs don't get let off easy. We need
balance, and we all have to do our bit,
however unfair that might seem to the
downtrodden denizens of Mayfair.
Tim M - this isn't a level playing field and gives private equity an unfair advantage ...
What a load of tosh. Quoted companies can use leverage just as PE-backed companies can, but they choose to retain balance sheets that are fat and inefficient. Interest is tax-deductible to ALL businesses. PE investors take on greater leverage (and hence risk) as they are willing to put in the work to ensure they do not default.
Quoted company boards remuneration is not as closely linked to performance as that in PE, so they are not incentivised to run the company as hard.
Don't follow this government's education policy of holding back the stars to appease the average.
I don't see any strong argument against further restricting the deductibility of interest payments. Leverage is available for all companies and the UK has adequate thin capitalisation rules already.
Carry is another issue altogether, but I would expect any radical overhaul of the tax treatment to be swiftly followed by a mass exodus of the very PE executives the changes were targeted at (resulting in potentially lower tax revenues than before for the Exchequer and a less competitive UK).
On a related note, it's not surprising to see Hutton fanning the flames!
Are we all here dealing with the real issue or our own pet issues? Is all this PE debate not really the symptom of an as yet "undisclosed" real debate? Can somebody please tell me what it really is? Does Joel know?
Dick wrote: "William - please define the contribution of PE to the UK economy. As far as I can tell the industry has absolutely no impact on real economic growth simply because it's not creating anything new."
The most common misconception of the PE industry is that it has a short term outlook and set of goals. This is not the case. Each private equity house must add value to a company under its control Private equity houses do not buy a business, sell its assets for personal gain and let it fall by the wayside or go bust. They buy a business, restructure it, and sell it on (often to another PE house) for a significant profit. The significant profit is additional value that they have added to that business, value that is longterm. In the long run, the majority of private equity run businesses take on more staff than those run by trade buyers as a result of this.
Perhaps it would help the debate if PE companies could show where they've managed to create jobs and whether these were well- paid or just minimum- wage. Also if these businesses depend on State contracts or if they are genuinely competing in the market place.
It is a misconception that you only contribute to the economy by creating jobs. Some jobs need to be destroyed and other ones created for the economy to stay competitive in the global market. What's more, it is not true that you cannot create value unless you do something to a company's operations. A company that has borrowed too little is, conversely, using too much equity finance. The lenders are not taking on enough risk for interest that they receive, and the shareholders facing too much of it. By borrowing more and freeing up equity capital, in such a situation, you are producing a higher risk adjusted return on the equity that is left, and that is creating value. It just goes into your pension rather than your payslip.