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U.K. LBO Firms Resigned to Losing Fight Over Tax Rise

Jon Moulton
"It's almost certain taxes are going to rise" said Jon Moulton who helped start funds that grew into two of Europe's biggest private equity firms. Photographer: Suzanne Plunkett/Bloomberg

U.K. private equity executives are lobbying against a government plan that may more than double the tax they pay on the profit from their investments. Privately, they say it’s a battle they’re resigned to losing.

The coalition government plans to increase capital gains tax from 18 percent to rates closer to those applied to income. Earnings of more than 150,000 pounds ($222,000) a year are subject to a 50 percent levy. The CGT increase may raise 1.9 billion pounds, the Liberal Democrats, the coalition junior member pushing for the levy, said before the May 6 election.

Carried interest, the share of profits that executives traditionally receive as the largest part of their compensation, is subject to capital gains tax. Dealmakers say they should be exempt from the rise because their work fuels economic growth. They are going to struggle to win that argument as Prime Minister David Cameron faces a near-record budget deficit.

“They are an easy political target,” said Andrew Goldstone, the partner in charge of the personal tax and estate planning practice at law firm Mishcon de Reya in London. “Capital gains tax is going up, and one of the big targets will most probably be private equity.”

Cameron says he plans to raise capital gains tax for “non-business” assets, promising “generous exemptions” for entrepreneurs. Pensioners, who face paying the levy as they sell second homes to fund their retirements, and business owners, are all pushing for exemptions in Chancellor of the Exchequer George Osborne’s first budget on June 22. Osborne will tonight address bankers at a dinner at the Mansion House in the City of London.

Tax ‘Injustice’

“It wouldn’t be appropriate to give private equity firms more favorable treatment than retirees,” Brendan Barber, general secretary of the Trades Union Congress, said in an interview. “Private equity is an area of the economy where injustice of the current capital gain tax regime is most evident.”

It would be “bizarre” if the dealmakers’ carried interest, their share of the profit from asset sales, wasn’t considered as “business,” Simon Walker, chief executive officer of the British Venture Capital and Private Equity Association, said after Cameron’s announcement last month.

“Raising the level of CGT to income tax levels would actually hinder endeavors to stimulate the economy and reduce the deficit, and result in a lower tax take,” he said.

Even so, taxes for the industry are likely to rise, executives said. The BVCA, the industry’s lobby group, wasn’t able to provide an estimate for how much the plans will cost their members.

Rise ‘Almost Certain’

“It’s almost certain taxes are going to rise,” said Jon Moulton, who helped start the funds that grew into CVC Capital Partners Ltd. and Permira Advisers LLP, two of Europe’s biggest private equity firms. “Firms have been paying very little taxes on their carried interest in the past. They will have to learn to work in a high-tax environment.”

The proposed capital gains increase would echo a draft U.S. bill that would make partners pay income tax of as much as 35 percent on carried interest, up from 15 percent. Meanwhile, the European Union is preparing legislation tightening disclosure and fundraising rules for private equity firms to limit risk.

‘Fair and Reasonable’

The changes to the capital-gains tax regime will be “fair and reasonable,” Cameron told BBC Radio 2’s Jeremy Vine show today, pointing that “for many years the CGT rate was 40 percent” and that “leakage” from income tax was costing the country 1 billion pounds a year.

With a wider gap between income and gains tax rates, “a lot of people turn income into capital in order to evade the tax system,” Cameron said.

Lawyers and accountants are already starting to work on ways to mitigate the increase. Some buyout fund partners may relocate to Switzerland, said Gary Heynes, head of the private clients group at London-based accounting firm Baker Tilly.

“Others are looking at crystallizing their gains now to secure an 18 percent rate, by transferring their co-investment or carry to a trust or a company for example,” Heynes said. The CGT rate may rise to about 40 percent, Heynes estimates.

CGT generated 7.8 billion pounds in revenue from April 2008 to March 2009, before the worst of the credit crisis hit, according to the government. Before the election, the Treasury forecast it will raise 2.7 billion pounds for the year starting in April 2010.

Carried Interest

Fund managers pay the 18 percent tax rate on the share of a fund’s profit, or carried interest, they receive from investors when all the assets have been sold above a minimum annual return known as the hurdle. Partners also pay the levy on gains made on their personal money they invest alongside their firms, usually 2 percent of the fund’s total.

U.K. firms generated about 2.1 billion pounds of carried interest in 2007, the peak of the buyout boom, according to estimates by London-based research firm Preqin Ltd. Senior partners and executives typically get two-thirds of that money, with junior dealmakers receiving the rest, according to Preqin. That would have netted the about 1,000 partners and top executives who work for the 340 U.K. firms an average of 1.4 million pounds each that year, calculations by Bloomberg show.

‘Two Years Late’

An increase in the capital gains tax to 50 percent would have boosted a partner’s carry tax bill by 446,000 pounds to about 700,000 pounds that year, the calculations show.

In the wake of the credit crisis, only a fifth of active private equity funds in the U.K. are making carried interest as returns dry up, according to Preqin.

“The argument that it would not produce much revenue is not politically good, but economically that’s true,” Mishcon de Reya’s Goldstone said. “The government is two years late.”

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