Private equity » Tax Research UK

Hedge funds: just what you need for tax abuse

Private equity, Tax evasion, Tax Havens Comments Off

Jan 172008

Marty Sullivan at Tax Analysts has been continuing his work on tax haven abuse, this time turning his attention to the use of hedge funds in the Caribbean by US investors as a way of avoiding and evading tax.

As he notes:

Previously we reported that tax evasion by individual investors in offshore hedge funds was a relatively easy undertaking. Information about investors flows only in a trickle from these institutions to onshore tax collectors.

In the latest edition he calculates that there were a total of $1.43 trillion in hedge fund assets under management at the end of 2006 and of that sum assets under management in Caribbean hedge funds amounted to $746 billion at the end of 2006.

He goes on to calculate that at the end of 2006, $262.8 billion has been invested by individuals in hedge funds domiciled in the Cayman Islands, the British Virgin Islands, the Bahamas, and Bermuda.

I stress, and he stresses, that there’s nothing wrong with that. But, as he also notes:

it is a fact that if income is not independently reported by the source, the likelihood of voluntary compliance declines precipitously. IRS statistics indicate that income with little or no information reporting has a compliance rate below 50 percent (“Rap on Tax Gap – It’s No Snap,” Tax Notes, May 21, 2007, p. 711, Doc 2007-11600 , 2007 TNT 93-8 ).

This ratio is considered reliable. How much is lost then? Hard to know for sure, but whatever it is, automatic information exchange would stop it. Compliance rates then climb to rates in the high nineties.

That’s why we favour such information exchange. And there is no reasonable argument against it (treat that as a challenge if you like: I don’t believe it possible to actually argue the case).

The Walker Code on Private Equity

Private equity Comments Off

Nov 202007

The Walker Code on private equity will be published today.

I have little to add to the despair I expressed yesterday when learning that Sir Mike Rake was to head the review process.

And in any event Brendan Barber of the TUC seems to have said it all when saying:

While disclosure is vital, the wider implications of the growth of private equity will not be touched by Walker.

I’d put it another way:

Self regulation does not work except for those so regulated.

Mike Rake – enough to make my heart sink

Ethics, KPMG, Private equity 2 Responses »

Nov 192007

Accountancy Age has reported that:

Sir Mike Rake has been given the high-profile task of policing the new code of conduct for private equity firms that will be released by Sir David Walker tomorrow.

The code is aimed at making the buy-out industry more open and transparent. According to the Times, it is a voluntary code that will adopt a ‘comply-or-explain’ approach to compliance and it will be up to Sir Mike to ensure that firms meet the requirements of the document or explain why they haven’t.

Sir Mike will chair the oversight committee that will enforce Lord Walker’s code. This committee will work with the British Venture Capital Association and meet three times a year to sift through details of the companies owned by buy-out groups.

Nothing could fill me with less confidence than Mike Rake fulfilling this task.

How can a man who watched his own firm nearly go to the wall and pay fines of $456 million because it failed to comply with so many legal and ethical requirements made of it possibly be suited to this role?

I despair.

A good day for Private Equity

Private equity Comments Off

Oct 102007

The private equity industry suffered almost no losses in yesterday’s PBR. And it was much the same in the States. The Tax Prof Blog reports that the front page story in today’s Washington Post is:

Buyout Firms to Avoid a Tax Hike; Reid Passes Word Senate Won’t Act

Senate Majority Leader Harry M. Reid (D-Nev.) has told private-equity firms in recent weeks that a tax-hike proposal they have spent millions of dollars to defeat will not get through the Senate this year, according to executives and lobbyists. Reid’s assurance all but ends the year’s highest-profile battle over a major tax increase. Democratic lawmakers, including some presidential candidates, had been pushing to more than double the tax rate on the massive earnings of private-equity managers, who the Democrats say have been chronically undertaxed.

Seems like it was a good day for them over there too.

But we won’t be going away.

The PBR Highlights

Accounting, Domicile, Inheritance Tax, Private equity, Tax management Comments Off

Oct 102007

Executive summary

A massively missed opportunity. The last thing we should expect from a Labour Chancellor. A political mistake – an admission that the Tories are indeed setting the agenda, and entirely for the benefit of their natural supporters.

Inheritance Tax

The one clever move in the PBR was to allow couples to use each others allowances. It kills the market in tax planning in this area and stops the accusation that only the rich can afford to avoid this tax. But it will cause harm. There will be less wealth redistribution. The housing market will continue to grow as less tax will be charged on house price increases. Overall, a mistake. He could have created partially transferable allowances quite fairly. And the rules on this will be complex – you can be sure.

Non-domiciles

The plus – he did something. It is now recognised that there is a problem. The other plus – he’s left the mega-wealthy as the abusers which makes it even easier to attack the injustice of this in the future. Otherwise, a complete lost opportunity to end an abuse, to raise money to tackle child poverty and to bring the UK into line with the rest of the world.

The issue will not go away. Expect an attack from Europe now. It is very obvious now that the UK is operating a harmful tax practice.

Overall, a massive disappointment and a political complete own-goal. It will backfire.

Capital gains tax

The biggest mistake in the whole budget. I’d called for a 20% rate of tax instead of the 10% one – but the 18% rate on all gains creates massive tax planning opportunities for accountants – so watch the abuses rise – and creates an incentive for people to speculate and not create wealth. In economic, accounting and political terms a straightforward disaster. And it does not nothing to tackle private equity.

Private equity

Because the non-dom rule stays for the wealthy and because the income of private equity partners is still going to be taxed as capital gains the reality is that he has done nothing of any consequence at all to tackle this abuse. So much for the Prime Minister’s words saying the loop hole would be shut. He clearly cannot identify a loophole, and that after ten years at the Treasury.

Small business

As predicted, the abuse of paying dividends without underlying economic substance in this sector is to go. I have written on this already, here. Expect a massive backlash from the small business sector, but reform here is required. The trouble is, on this track record, he’ll bodge it by ducking the real issues.

PAYE and NIC

There had been a call for these to be merged. They won’t be. At an admin level this is an opportunity lost. The protection of pensioners could have been managed.

Overseas aid

At last – some good news. But please spend it wisely – and it must not be linked to UK exports.

Domicile, private equity and capital gains tax

Domicile, Economics, Private equity, Tax avoidance, Tax management 11 Responses »

Oct 092007

Time for some quiet reflection on the budget.

Let’s consider the related issues of domicile, private equity and capital gains tax. Alastair Darling had to do something on these issues. Earlier this year we had the farcical situation of some in the private equity industry saying they were paying tax at lower rates than their cleaners. There were three reasons:

1) The income of the partners in many private equity firms is taxed as capital gains under an agreement between the Treasury and the British Venture Capital Association – an agreement that does not even have the force of law. But it is income. Nothing else. And to tackle the issue the Chancellor had to say that was how it would be taxed as income in future. But he did not. He’s left this abuse in place.

2) Capital gains on business assets could be at rates as low as 10% before today – just one quarter of the top rate of income tax. You can see how this massively advantaged partners in private equity firms, and massively increased the value of their earnings. That’s all they paid on most of their income, even if they were domiciled in the UK. But there was good reason for the 10% rate. It was low to reflect the fact that many real entrepreneurs, as opposed to the financial manipulators of private equity, work for many years to create the value they realise on sale of their small businesses. The low rate reflected that fact. But the Chancellor is now going to penalise them with an 18% tax rate on all capital gains (which will, incidentally be far too low when applied to non-business assets – leading to all sorts of abuse including the provision of massive incentive for any income to be recategorised as gains – something accountants were immensely good at many years ago before the income tax and capital gains tax rates were aligned for non business assets held in the short term). This will discourage small business and massively encourage financial speculation, which adds no benefit to this country at all. And it will leave private equity partners still paying tax at less than half the rate they should be paying under income tax rules.

3) The domicile rule has been exploited by many in the private equity business. This is easy. First of all, and contrary to the image they would like to present of adding value to the UK economy, most private equity activity is actually registered offshore. That means that anyone who is non-domiciled and an owner of a ‘carried interest’ or investment in such a fund will immediately have an offshore asset as a result. So any capital gain they make on it will be outside the UK. That means the remittance rule applies immediately, at a mere cost of £30,000 a year. So any capital gains tax they pay on this will remain entirely voluntary, dependent entirely upon whether they decide to remit funds to the UK or not. So those private equity partners who are non-domiciled (and the Observer thinks that’s 80% of them) will just laugh at the increase in capital gains tax that the Chancellor has announced to tackle abuse in this sector – they won’t be paying it anyway.

So, how has Alastair Darling faired? Appallingly. Far from tackling abuse he has encouraged it by:

a) Confirming that tax dodging by the private equity sector is still OK;

b) Confirming that the domicile rule survives, even though I have shown that it is illegal under the UK’s Race Relations Act;

c) Has confirmed that it is OK for the very wealthy to, as Lord Gill said to “not so much [be] taxed by law as untaxed by agreement.” I have suggested this is illegal, and think this true and seriously hope it is challenged by EU member states.

d) Has harmed the UK small business sector to spite, but has not harmed the private equity sector. The result will be untold cost to real enterprise in this country by increasing the capital gains small businesses pay;

e) Has created untold opportunities for tax abuse by more than halving the rate of capital gains tax, which will not doubt be a cause for widespread tax celebration up and down the land amongst the UK’s tax fiddling accountants;

f) Has shown himself politically inept by closing a five year review on domicile by simply copying a Tory conference announcement from a week ago: no other interpretation is possible;

g) Has let the private equity industry carry on unhindered in harming the UK economy and the job security and prospects of those who work in it;

h) Has failed to raise £4.3 billion to tackle child poverty – which he could have done, meaning he’s effectively giving a continuing subsidy of over £3 billion to the very rich at cost to the poorest children in this country;

i) Has ignored calls from the CBI, FT and others to end tax abuse.

How many points does he get for that? Precisely none.

This is a disastrous showing from a man who needs to tackle tax abuse if the numbers are going to stack over the next few years. And it does not reflect too well on his boss, come to that.

What part of loophole don’t you understand?

Ethics, Private equity, Tax management Comments Off

Sep 282007

The Guardian has noted that the back tracking on private equity has begun in the Treasury.

Gordon Brown said on Wednesday that:

Private equity will be dealt with in the PBR. I can assure you that we will do so.

Th[e] matter will be looked at in a few days and weeks and wherever there is a loophole that there should not be, we will take action. I may say that since 1997 we have closed a massive number of loopholes where they exist. Sometimes it is very difficult to do so because there are lawyers and accountants who are always trying to find loopholes. On this issue of private equity, I can assure you that we will do so.

Now the Treasury has said:

The [private equity] review was still under discussion and no decision had been taken. The prime minister’s statement merely reinforced the government’s conviction that tax abuses would be tackled.

and:

We don’t believe he said that the private equity industry was abusing tax loopholes.

This almost beggars belief. I know the Treasury is full of market economists providing it with a massive bias towards market abuse that creates enormous tensions with HMRC, with whom they share the building, but to suggest private equity interest reliefs, its extensive use of offshore, manipulation of the domicile rule and the abusive nature of the agreement on the taxation of carried interests are not the exploitation of loopholes is just plain daft.

Everyone knows that private equity is exploiting loopholes. That debate is over. As such it’s time the Treasury faced reality. Which means dropping some of the blinkers that an economist customarily uses to avoid doing so.

What accountants say

Domicile, Ethics, Private equity, Tax management Comments Off

Sep 272007

I was amused by this in the Guardian this morning in a discussion on the domicile rule:

Accountants have estimated that if 20% of private equity businessmen left the country if the practice ended, Britain would still be better off by £4.3bn, equivalent to more than a penny off income tax.

I admit I have yet to get used (and expect I never will) to a piece of my research becoming the accepted norm.

But the fact is that this number, transparently calculated, is now the figure that others have to prove wrong in this debate. No one has yet risen to the challenge that I’m aware of. Instead we get, according to the Daily Mail a report that:

At an industry conference in tax haven Monte Carlo, Wol Kolade, chairman of the British Venture Equity & Venture Capital Association said it was time to ‘separate fact from fairytale’.

Note where he said it! He, apparently then:

called on the private equity industry ‘to fight back against the myths that surround it’. He said: ‘When you look at the facts and consider the real story of private equity, it is clear that it is good for companies, good for employees, good for the economy and of course good for investors.’

Tell that to those who now hold Debenhams’ shares or to the employees of the AA. But most of all, he must live by his own mantra. According to the Telegraph he said:

the industry generated £26bn in taxes last year, and said millions of pensioners benefited from investments in private equity.

I bet that £26 billion includes PAYE from staff, VAT from sales, NIC and anything else he can find, probably using PWC’s illogical Total Tax Contribution methodology. This, by the way was developed in the Mohamed al Fayed school of accounting when he first used it to justify the fact that he had a fixed price income tax deal with the Revenue. Bob McIntyre gave short shrift to that, and so should we to this absurd claim by the BVCA – which promotes fairytales, not facts.

Brown says he’ll end private equity loopholes

Accounting, Domicile, Private equity, Tax Havens 1 Response »

Sep 272007

The Guardian has reported that:

Gordon Brown yesterday announced that he will close some of the tax loopholes enjoyed by private equity companies in the pre-budget report due to be published next month on the same day as the comprehensive spending review.

It also notes he said that:

Private equity will be dealt within the PBR. I can assure you that we will do so.

and

That matter will be looked at in a few days and weeks and wherever there is a loophole that there should not be, we will take action. I may say that since 1997 we have closed a massive number of loopholes where they exist. Sometimes it is very difficult to do so because there are lawyers and accountants who are always trying to find loopholes. On this issue of private equity, I can assure you that we will do so.

I hope he means it. Really means it. But I have my doubts. As the Telegraph noted:

[H]e declined to answer a question over whether the non-domicile tax rules would also be overhauled

That’s the worrying bit. Unless you make the carried interest in private equity funds subject to income tax then leaving the domicile rule intact would mean that whatever is done to Capital Gains Tax rules 80% of all those who benefit from owning those carried interests will still do so effectively tax free as they are non-domiciled and so can record their capital gains offshore. This is not a question of either / or. It’s a matter of both or no benefit.

That’s why I have my doubts.

But I’ll agree with him on one thing: lawyers and accountants who are always trying to find loopholes.

And if I was Alistair Dailing I’d be worried about something else. Whenever did Tony Blair announce tax policy? But I note Gordon Brown still is.