Judging from the immediate reaction to chancellor Alistair Darling’s decision
to scrap taper relief and introduce a flat rate of capital gains tax of 18%, one
would assume that private equity had been so battered by the change that the
industry was ready to pack its bags and exit en masse.
But are the changes really that bad for the industry? Will scrapping taper
relief, spun as ‘closing private equity loopholes’ in the pre-Budget report, in
fact benefit the sector rather than hinder it?
After the initial shock that the very attractive 10% CGT tax rate on assets
held for two years had gone, buy-out bosses are now probably happy enough with
the final outcome.
Firstly, a rate of 18% is hardly unattractive. Industry heads have admitted
as much. ‘It is notable that in the Treasury Select Committee hearings earlier
this year, evidence was heard that the private equity industry could live with a
tax rate of 15% to 20%,’ says Ernst & Young head of tax policy Chris Sanger.
More importantly, though, is the fact that buy-out houses will now have the
opportunity to sell-on assets much faster than under the taper relief regime,
and actually end up paying less tax.
The way private equity is structured means that firms make their significant
profits when they sell on an investment.
Under taper relief, private equity groups would have to hold on to assets for
at least two years in order to attract the 10% rate. Selling within two years
would attract a CGT charge of up to 40%.
Would the private equity groups that bought Debenhams in 2003 and floated it
for a £500m profit 30 months later have exited earlier if the taper relief had
not been available at the time? It is a possibility.
With this restriction now out of the way, private equity can sell on a
business with an 18% tax change, whether they have held it for six months or
five years. The new rules will give firms the freedom to sell investments at a
much faster rate, and because of the way PE deals are structured more frequent
exits could mean bigger profits.
Finally there is the question of simplification. The new regime will make it
significantly easier to administer and manage funds and investments. The
potential for cost savings from less red tape are significant.
The bottom line is that a move designed to ‘clampdown’ on buy-out houses
could in fact open the doors to greater prosperity and fatter profits.
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