The ‘tax gap’ on carried interest allows Private Equity (PE) fund managers to access capital taxation rates of 28 per cent, rather than those of income rates, which attracts a top rate of 45 per cent, plus national insurance.
The Labour Party plans to change this if they come into power, closing the “loophole” on one of three main income streams accessed by private equity fund managers.
Coupled with plans for changes in tax breaks for non-domiciled individuals, concerns among PE fund managers triggered fears of an exodus of wealthy investors to more tax-friendly jurisdictions. However, subsequent announcements by would-be Chancellor, Rachel Reeves, indicate fund managers who have “skin in the game”, also known as “risk capital”, will still be able to access capital tax treatment, should Labour win.
Commenting on what this could mean for PE fund managers, Chand Chudasama, Strategic Corporate Finance expert and Partner at accountancy firm Price Bailey, says: “From my experience, the vast majority of the Private Equity industry – particularly at the senior end - already invest personally in their deals and funds. People have had real skin in the game for many years and most invest quite meaningful percentages personally. I expect that the extent to which fund managers don’t have personal risk capital on the line will be much smaller than Labour's estimate and that means the “loophole” could be much smaller than Labour’s estimates.”
“Where this tax might catch people out is more the poorly governed funds and the middle ranks of some larger private equity funds. These are the non-partners who are on for performance-related bonuses. However, as many in this cohort will know, it is increasingly hard for the middle ranks to get access to meaningful carry, and where it does happen and they are not putting risk capital in then, frankly, the existing tax legislation probably already prohibits many of them receiving capital tax treatment.”
Chudasama continues: “Where fund managers are structured as LLPs, which is very common in UK PE, the existing rules on disguised salary, influence and capital contributions are already quite clear for the Partners too.”
“HMRC has strict tax-avoidance policies in place and if the only reason an LLP Partner invests is to pay less tax, they will struggle to defend an investigation. This should not be an issue for a well-structured, commercially minded, PE fund though as those organisations will be using Partner capital wisely, for example to balance different sources of finance with varying returns requirements according to commercial needs or to maintain voting rights.”
“This is probably what the current narrative on taxing the PE community further has missed – there are already rules in place that impact both the Partners and the staff and whilst enforcing or even enhancing them is sensible, many funds are already compliant so the size of the tax prize is probably quite small.”
The United Kingdom is home to one of the largest and most active private equity industries worldwide, with London attracting nearly half of all private equity investments in the UK. The UK, particularly the city of London, has become a European hub for private equity.1 According to a ranking by Statista, based on Private Equity fundraising capacity in the last five years, five out of 10 of the leading private equity firms in Europe are located in London. It’s estimated that private equity-backed businesses generated £286 billion in GDP in 2023 in the UK, accounting for 6% per cent of the country's total.1
In total, businesses supported by private equity and venture capital, their suppliers, and related consumer spending support an estimated 4.4 million workers earning £150 billion and generating £286 billion of GDP in 2023, according to the BVCA.2 Since 2021, total employment supported by private equity and venture capital increased by 15%, supported employee earnings increased by 32%, and supported GDP increased by 37%.2
Additional information on Private Equity Funding can be found here: https://www.pricebailey.co.uk/services/corporate-finance/private-equity-funding/?utm_source=pe+loophole+election+&utm_medium=pr
Information on earlier stage investment and the state of the UK venture capital market can be found here: https://www.pricebailey.co.uk/ebooks/raising-venture-capital-funding-really-takes-true-venture-entrepreneurs-access-equity-funding/?utm_source=pe+loophole+election+vc&utm_medium=pr
Sources:
1. https://www.statista.com/topics/9613/private-equity-in-the-uk/#topicOverview
