EUROZONE: Is carry personal, or business?

The winds of change are blowing through private equity real estate firms in the UK following the installation of the new coalition government. 

One of the first things made clear in the days following the Conservative and Liberal Democrat power-sharing pact is that the coalition is prepared to raise capital gains tax from 18 percent to 40 percent, or even 50 percent, which could hit GPs where it really hurts – right in their carried interest. 

Currently, GPs pay tax on carried interest as a capital gain, rather than as income. The existing capital gains rate is 18 percent, so one could argue that GPs have been fortunate that carried interest is not treated as income for tax purposes. If that had been the case GPs would already be subject to 40 percent tax on earnings between £37,401 (€43,478; $53,960) and £150,000 – and 50 percent for those earning more than £150,000. However, ideological redistribution of wealth arguments aside, a rise in CGT to 40 percent is still not something to celebrate for the UK-domiciled GP.   

At the moment, it is not clear whether the proposed CGT-hike will actually catch the carried interest at all. The plan was only put out by the coalition on 11 May, in the days after the British election. In an agreed text, the new coalition said, under the ominous sub head of “tax measures”, that they had the ambition of increasing personal allowances on income tax to help those on low and middle-incomes. This would be paid for by raising CGT – aimed at hitting higher earners such as those that can afford to own two or more homes.  

GPs can cling to the hope that an increase in taxation will not hit them, but at the moment they are in limbo. 
The tax measures text added that the increase would not be applied to “business” capital gains and there would be a generous exemption for “entrepreneurial business activities”.

“For private equity, the big question is whether the carried interests owned by private equity executives are going to be treated as business assets under the new regime,” says tax expert Jonathan Hornby, at restructuring firm Alvarez & Marsal. This is because the higher rate would only apply to “non business” assets. 

Hornby adds that if it does affect carried interest, the most immediate impact would be on those UK firms raising a new fund. Firms will have to work overtime on structuring the vehicle in an effort to neutralise the threat. 

Various groups in the UK, such as the British Private Equity and Venture Capital Association (BVCA) are monitoring the planned tax hike and hope to lobby the government on the issue.

The BVCA argues that private equity and venture capital firms are playing a role in the economic recovery and that, rightly, their capital gains should be considered to be “business”. “It would be bizarre if it did not,” the association said. 

It also points out the inherent error in assuming that an increase in CGT would garner more revenue for the nation. 

The last time a UK government raised the rate of CGT – in 2007 when Labour raised it from 10 percent to the current 18 percent – the revenues accumulated fell sharply from £5.3 billion in 2007/2008 to £2.5 billion in 2009/2010. 

In addition, the BVCA argues that Britain already has a relatively high rate of CGT. In Australia, New Zealand, the Netherlands, Hong Kong and Switzerland, among others, the rate is zero – the inference being that GPs might move abroad if pushed any harder. Terra Firma’s Guy Hands has already made the move out of the UK to Guernsey, in the Channel Islands.

I am not sure that last argument will find much sympathy with a government facing a huge financial deficit, but I certainly wish the BVCA and others well in their efforts to make sure private equity real estate is not unfairly penalised by the UK’s new government. 

If you are looking for immediate comfort, though, maybe this will help a little: the CGT plan was pushed upon the bigger of the two parties, the Conservatives, by the Liberal Democrats’, Britain’s third political party behind Labour. 

The Conservatives would traditionally be considered the natural bedfellow of private equity. The Times newspaper reported last year how Lord Chadlington – who bankrolled Prime Minister David Cameron’s bid to become Conservative leader – trained four private equity chiefs before they gave evidence to a House of Commons committee investigation recently. 

Let’s hope private equity real estate has enough friends to influence matters should push come to shove.