The Guardian ran a special feature on private equity on Saturday. It referred to the tax incentives associated with this activity, but missed the essence of this taxation issue, which appears to have been universally overlooked.
There is little problem with private equity using borrowed money to buy companies and getting tax relief on the interest paid if that interest is paid to a recipient in the UK, who is then taxed on it. Likewise, making a capital gain on turning a company round has always been a part of capitalist activity, and is acceptable if the gain is taxed in the UK, where the company giving rise to the gain is located. And having a parent company charge a UK subsidiary for the management services it supplies is fine if the resulting income is taxed in the UK.
But the private equity market seeks to break these rules. If the interest it pays goes offshore it is not taxed there. The gains it makes are often recorded as arising in places like the Channel Islands where such gains are untaxed. And the management fees that the private equity companies charge to their subsidiaries often end up in places like Guernsey, where no tax might be paid.
That means tax relief is obtained in the UK on the cash flows going offshore but no tax is paid when they get there. This means the UK government is subsidising the private equity market to transfer wealth out of the UK to the private backers of this activity. That is why they make above average rates of return on the funds they invest. It's easy for anyone to do so when they don't pay the tax that might be due if they declared their income in the UK, as they should since this is where it arises.
This subsidy is being used to undermine UK employment, the UK capital markets, the tax income of the UK government and the standards of corporate governance and social responsibility we expect of business in the UK.
The answer is simple. Tax relief on interest paid offshore has to end. Management fees paid offshore have to be subject to tax deduction at source when paid and asset owning companies located offshore should be assumed to be located in the UK. Then tax would be paid here. That would create a level playing field. Private equity could not compete on that basis.
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[…] Private equity – subsidised by the UK to transfer our wealth offshore […]
Richard
I do not understand how you envisage this tax avoidance takes place.
You state – “If the interest it pays goes offshore it is not taxed there.” Yes but any interest paid to a tax haven country is subject to UK withholding tax at 20%? This is more than the UK small company rate and not that far off the mainstream rate after all.
Any capital gains made by a UK resident and domiciled individual or company are subject to UK taxation.
Management Fees can be (and are) tackled adequately by the correct use of the transfer pricing legislation.
I am aware that specialist units of the Revenue have been focussing on the private equity/ hedge fund industry for some time. I do not believe the tax leakage you imagine is happening is really the case.
Do you agree it might be fair to enlighten Guardian readers a little more or shall I?
Andrew
Andrew
I note you are a \’CTA\’ – a chartered tax adviser so I\’d hope you know the law.
Unfortunately your undertsanding of the realities in this case seems limited. Interest can and is routinely paid from the UK without deduction at source, as I would presume you know. That\’s the whole basis of the offshore banking world. Interest paid to offshore banks who finnace these deals is paid gross, for which clearance (if needed) is readily available. There wouldn\’t be about £180 billion in Jersey otherwise, I can ssure you.
Second, the precise point is that the holdings subject to capital gain are structrured offshore so that gains are not taxed. Your argument is a little disingenuous in the circumstances, not least because private equity is a corporate issue and yet you primarily relate your argument to the law of tax concerning individuals.
Third, whilst management fees can be subject to transfer pricing challenge, that\’s a game that many companies win, simply due to lack of resource to challenge them.
In which case the argument you put is wrong. Which is precisely why there are units to challenge this activity. After all, what would be the point otherwise?
In the cirumstances, I leave it to you to decide whether you wish to expose your \’undertsanding\’ to a wider audience.
Richard