Labour’s private equity tax raid would ‘substantially weaken’ UK PLC, experts say

Private equity experts have denounced the UK Labour party’s plans to implement a £440m tax on dealmaker profits, arguing that the move could stem the flow of UK investment and damage the economy.

“While the UK has experienced a wealth of private equity takeovers in recent years, indicating how attractive the country is as an investment opportunity, plans from the government to increase taxes could risk halting the investment from PE firms,” says Claire Trachet, CEO of Trachet, an M&A advisory firm.

The plans, which were first announced by Labour in September 2021, would seek to close a controversial loophole allowing carried interest on private equity deals to be taxed as capital gains at 28%, as opposed to ordinary income at 45%.

Supporting the proposals in a paper published in the British tax journal on 9^th March, Dan Neidle, former head of tax at law firm Clifford Chance, argued that most private equity funds should be treated as “trading” for tax purposes. He went on to posit that, based on analysis of figures obtained via freedom of information request, HMRC is missing out on around £600m per year as a result of the carried interest loophole.

But in spite of this, Trachet goes on to argue that any deterrent effects created by the legislative changes would be detrimental to the UK economy, particularly in the current climate.

“Losing these dealmakers could be a critical loss for the UK market, which continues to battle rising interest rates and inflation. This also comes at a time when investors have just become less risk-averse, they know that opportunities are presenting themselves and therefore are no longer frozen.”

Restoring fairness in the tax system

The controversy surrounding the taxation of carried interest in the UK spans decades. Dissenters commonly argue that the current rate stems from a lobbying agreement between the treasury and industry in the 1980s, and is conceivably unlawful by modern standards.

Most recently, entrepreneur and Labour party donor Dale Vince revealed that he is planning to challenge HMRC over the current regime. According to reporting by the Financial Times, Vince’s lawyers have addressed a “pre-action protocol” letter to the tax authority indicating that they intend to seek a judicial review of its approach to taxing the private equity sector.

Announcing the plans to close the carried interest loophole in 2021, Labour shadow chancellor Rachel Reeves argued that “working people and ordinary businesses have been hit by a jobs tax while private equity fund managers don’t have to pay a penny more on their income”. The move would “start to end the unfairness in the tax system”, she added.

Fresh analysis conducted by law firm Macfarlanes supports Reeves’ position. A group of 255 top private equity dealmakers in Britain earned £2.7bn in carried interest in the 2020-21 tax year, accounting for about 80% of all carried interest earned, it found.

Similarly, research has found that while only around 2,000 people receive carried interest income in a single year, the average sum involved is £1m.

‘Weakening the UK’s competitiveness’

But according to Serena Lee, tax partner at law firm Akin, a tax hike on carried interest would create a “uniquely unfavourable regime for private equity executives” and “substantially weaken the UK’s competitiveness in this area”.

Lee points out the UK’s approach to the taxation of carried interest is consistent with that of many other European countries. For instance, Spain introduced new rules based on the UK regime in December 2022, while Italy has been successful in attracting financiers since amending its regime in 2017.

She also notes that the UK’s regime is “in many respects less favourable” than some other countries – the US, for instance, taxes carried interest at 20%. With this in mind, a further increase to the UK’s rate would be detrimental for the economy, she argues.

“The asset management industry bring substantial economic benefits to the UK beyond revenue from personal taxes: it creates jobs, supports professional services, and encourages investment into local businesses.

“Asset management professionals are often internationally mobile. Many other jurisdictions would be more than happy to snap up these individuals.”

Echoing this, and defending the integrity of the UK’s taxation of private equity funds, the British Venture Capital Association argued in a written statement that the current regime is “consistent with other jurisdictions around the world” and “wholly consistent with the law”.

“The current regime drives long-term, patient investment and is good for pension savers and charities, as well as for the financial services industry and the wider UK economy,” the industry body added.