Private equity » Tax Research UK

CBI says outlaw abuse, but not right now

Domicile, Economics, Private equity, Tax Justice Network 1 Response »

Sep 112007

Richard Lambert, the head of the Confederation of British Industry spoke to the TUC today. This spirit of cooperation is the first bit of good news.

The second bit is that the FT reports that he said:

I do agree that there is a legitimate question on the non-dom side. It is important that a tax system should be seen to be fair and open, that there should not be any whacking loopholes that undermine the whole approach. So we need to know more about the non-doms.

What more do you need to know, Richard? The answers are all available here and here. The rule has to go.

The third bit of good news is that he said:

My feeling strongly always has been that if it’s a duck, tax it like a duck; if it’s income tax, tax it like income and if it’s capital gains, tax it like capital gains.

That’s settled then. Let’s tax carried interests in private equity as income, which is what they are. The BVCA Memorandum of Understanding with HMRC in 2003 was a document that said income was a capital gain. It’s obviously wrong.

So that should be the CBI 100% behind things I’ve been campaigning for. The logic of the argument has been conceded in both cases.

But hang on a minute. Mr Lambert then said:

We need clarity on what actually is going on before we spring off and come up with solutions.

and that it would be wrong

to push back against the forces of globalisation, by being protectionist and restricting cross border flows of goods and services, and by slashing the income of high earners through the tax system. That would be disastrous and have serious consequences for growth and employment. It would cut the UK off from the benefits of open markets and free trade, and both capital and talent would drain out of our economy into someone else’s.

Where’s your evidence Richard Lambert? There is none. And as Simon Jenkins (former political editor of the Economist) said recently in the Sunday Times:

The claim that executives with families well installed in London and country houses will suddenly vanish to Monaco or the Cayman Islands if not paid millions more each year (or if fully taxed on those millions) is absurd. It ignores the role of location, lifestyle and other nonpecuniary perks in a modern executive’s career package.

He added:

London’s financial preeminence is based primarily on its lax market regulation and its agreeable living conditions for those not reliant on public services. Businesses will leave Britain not when executives are properly taxed but when they start losing money.

I’ve argued the same thing, often. And Jenkins is right, and shows Lambert’s claim for what it is: a request that the abuse stop, but not just yet.

It’s time the CBI smelt the coffee. Or should what bit of tax justice on domicile and private equity it neither understands and can disprove despite now agreeing the logic of our arguments.

Will changing the private equity rules increase tax paid?

Ethics, Private equity, Tax avoidance, Tax management Comments Off

Aug 302007

One of the regular challenges I face is the suggestion that whatever changes to the tax rules are made the rich will never pay tax. Tim Congdon raised it continually (and annoyingly) on Hecklers last week, for example. In a way, everyone who says this reworks the now near legendary comment in tax justice circles made by a chap called Guy Smith who worked for Moore Stephens who said to the Guardian in 2004:

No matter what legislation is in place, the accountants and lawyers will find a way around it. Rules are rules, but rules are meant to be broken.

The latest argument to this effect comes in a paper by a chap called Michael S Knoll who is at the University of Pennsylvania Law School; University of Pennsylvania – Real Estate Department in a paper entitled “The Taxation of Private Equity Carried Interests: Estimating the Revenue Effects of Taxing Profit Interests as Ordinary Income”. There’s quite a good summary of it (because it’s about as dry as its title) on this tax avoidance site (which presence there gives you some idea of the flavour of what’s to follow).

Michael Knoll suggests that if private equity partners in the US were taxed at the 35% income tax rate that they should pay on their earnings (for what is what they are) rather than the 15% tax rate they actually pay on capital gains (which they are not) then the additional revenue that might be raised for the US government would be at least $3.2 billion a year, assuming no avoidance behaviour.

It’s curious that LowTax.com call this “negligible”. I somehow doubt they say that of all government waste – because tax not collected is, of course, the same as money misspent. But in practice they are, anyway, wrong. For a start this sum is 1% of the US tax gap. Given that half of that, at best, will be recoverable this makes the sum material and far from insignificant.

Note however that both Knoll and LowTax.com promote the idea that in practice this tax would not be collected. Knoll argues that the partners in these funds would shift the burden of their tax to others. Those others might be their clients who might have to pay more than the 20% fee they already pay for the services of private equity operators, or the companies they manage, recharged to them as fees for management services. That will in turn be a cost born by the client in due course.

The assumption is extraordinary. Knoll specifically recognises it. He seems to accept in doing so that private equity operators think they have a right to an after tax income and others have a duty to provide it to them if that tax rate changes.

Those others, it should be noted, include pension funds and other mutual investors these days in addition to the more traditionally wealthy. But both Knoll and LowTax.com assume that this exploitation of those unable to respond directly to this abuse will happen. Implicit in that assumption is the belief that those who represent those collective investment vehicles that will be exploited, be they pension funds, other mutual funds or even charities investing their endowments will not protect their client who engages them as investment manager. That is, of course, likely to be true since those investment managers are part of the same financial hierarchy as the private equity operators.

It’s precisely this willing acceptance of fiscal and financial abuse that the Tax Justice Network challenges. We believe in the right of the state to tax. We think that this is legitimate. We think taxpayers should comply with the requirements of the states in which they earn their income. But we also oppose measures, whether in legislation or in so called professional practice that shift the burden of tax from those best able to pay it to these less able to do so. And this is why we object to private equity practices.

If private equity really is the right way to manage a business so be it. I won’t argue. But if it’s a medium for tax abuse or for making the tax system ever more regressive then I will. And so will my colleagues. Because that’s an abuse of social justice, and ethical financial practice come to that.

Private equity cannot be solved by tinkering with CGT

Domicile, Private equity 2 Responses »

Aug 222007

Accountancy Age has covered a story first reported by the FT and says:

The private equity industry is facing a tough shake-up in the way it is taxed, with chancellor Alistair Darling proposing stiffer capital gains tax (CGT) rates and lengthening the taper relief period.

According to the FT, Darling is considering an increase in CGT from 10% to 20% for businesses classed as business assets as well as an increase in the taper relief period from two years to five years.

I’m all in favour of the 20% rate. There never was a reason for the 10% rate, which was far too low.

I’m also quite happy that:

Also under consideration is the idea of drawing a tax distinction between mega-fund buyouts and small venture capital deals.

I’ve made clear, I agree with this. These are two quite separate activities which have fundamentally different risk profiles and roles to play in the economy.

But you can bet your bottom dollar that this is right:

The reforms were reportedly discussed in meetings last week between Treasury officials and private equity representatives. Buy-out bosses are said to be relieved by the proposals, as they feared much harsher measures.

They must be laughing themselves silly. The simple fact is that only private equity employees pay capital gains tax on their earnings from employment. Everyone else pays income tax. And all Alastair Darling is proposing to do is double their capital gains tax rate to a level which will still be half of that which is due under income tax rules.

This is madness. Not least because as the Observer has (I think reliably) pointed out, at least 80% of those involved are non-domiciled and as such can record their capital gains outside the UK, and so tax free.

For heaven’s sake, it’s time for the government to smell the mood of the nation and stop tax abuse of this sort. Let’s have a level playing field, now.

Private equity will survive paying tax

Economics, Private equity Comments Off

Aug 012007

The FT reports this morning that:

Buy-out groups could find ways to get round a proposed US tax rise by developing new financing structures or by offsetting some of the burden by cutting returns to pension funds and other investors, a private-equity executive said on Tuesday.

It continued:

Bruce Rosenblum, chairman of the Private Equity Council and a top executive at Carlyle, said big groups such as his would be able to “weather the storm” if Congress passed a bill that would greatly increase tax on private-equity and hedge-fund managers’ earnings. But he predicted that such a law would eventually diminish the sector, make the US less competitive and put smaller firms at risk. “There will be deals that won’t get done, entrepreneurs that won’t get funded, and turnarounds that won’t be undertaken,” he told the Senate finance committee.

I entirely agree with those last comments. But let’s be clear: if these commercial activities can only survive with state aid (and that’s what this tax subsidy is) then they shouldn’t be happening. State aid is not intended for that purpose. So this is welcome, not a problem.

Ten years on – and domicile is still on the agenda

Domicile, Private equity Comments Off

Jul 312007

It was interesting find an article on on our domicile rule in the International Herald & Tribune of 5 July 1997. It said:

A standard test for trainee British tax accountants is to decide whether Britain is a tax haven. According to Richard McIlwee, a tax partner with Clifford Chance in London, most are surprised to find that for certain expatriates the answer is yes.

Expatriates enjoy a number of tax breaks that are unavailable to residents. For the most part, these benefits are based on Britain’s unusual domicile rules.

It continued:

But following the election of the Labour government in May, the question now is whether Britain’s expatriate benefits will continue and, if they do not, what options will be available to foreign residents in Britain.

Rumors that the new Chancellor of the Exchequer, Gordon Brown, was looking closely at Britain’s domicile laws began circulating ahead of the budget. Although some of his earliest policy changes – such as partially freeing the Bank of England from government control – were welcomed by the British investment community, many people have still to be persuaded that the new government is truly pro-business.

Now compare that with the Treasury Select Committee report published yesterday:

Whilst recognising that the issue is not exclusive to private equity, we also ask the Treasury to inform us of the progress on the 2003 review of the residence and domicile rules as they affect the taxation of individuals, and note that the Treasury and HM Revenue and Customs need to demonstrate a rigorous approach towards claims of non-domicile status.

Think what abuse could have been prevented if Gordon Brown had acted in a timely fashion.

Treasury Select Committee to look at domicile

Domicile, Private equity Comments Off

Jul 292007

The Treasury Select Committee is to publish its interim findings on private equity tomorrow. This will not make recommendations: the committee has yet to hear all evidence, including that which I wrote for the Tax Justice Network.

But what is good news is that they are to ask for a progress report from the government on the domicile issue. As Nick Mathiason reports in the Observer:

It might be a contender for the longest ongoing government review ever conducted without reaching a conclusion. But now a powerful group of MPs will demand that the Treasury comes clean and publishes its four-year long investigation into the controversial non-domicile tax status that allows the super rich to avoid paying tax on the bulk of their income.

The demand comes from the Treasury Select Committee in its initial findings, unveiled tomorrow, from a high-profile investigation into the private equity industry. Its demand will prove embarrassing to the Treasury, which, under Gordon Brown, launched the non-dom review in 2003.

I am, of course, delighted. It’s this blog that has helped put domicile back into the middle of the political debate. It’s where it belongs right now. Much more than things like Arctic Systems do if ministers are really concerned about the fairness of the UK’s tax system.

And I rather like the idea of being called to give evidence on the domicile issue as well.

Private equity gets it wrong

Private equity Comments Off

Jul 242007

I note that the Alliance Boot private equity deal has run into problems. As the FT says:

The private equity owners of Alliance Boots and their banks have been forced to extend discussions on the debt package to fund the acquisition into next week after failing to reach agreement with investors.

The debt now looks set to cost about £250m more than expected for the record £11bn leveraged buy-out, according to people familiar with the terms.

Three comments:

1) Criticism is increasing the cost of capital for private equity. Good.

2) Future deals will be harder to fund. Good.

3) Those ‘so clever’ people in private equity don’t look so clever after all. But then we knew that.

ICAEW – all in a spin on private equity

Private equity Comments Off

Jul 182007

Accountancy Age has noted that:

Private equity’s ‘failure to play the PR game’ has forced it on the defensive, the vice-chairman of the ICAEW corporate finance faculty, Ian Leaman, said ahead of today’s publication of the Walker report.

Why can’t the ICAEW, just for once, accept the possibility that spin is not the answer to everything and that the reason why private equity is on the defensive is that it has been given inappropriate and socially unacceptable tax advantages which it has used to abuse the UK economy?

I explain more here but if you prefer the video, that’s here.

Private equity – TJN submits evidence

Economics, Private equity, Tax Justice Network 3 Responses »

Jul 162007

The Tax Justice Network UK has submitted evidence to the House of Common’s Treasury Select Committee examining private equity. I was author of the submission. The summary says:

This submission argues that private equity funds enjoy three unwarranted tax breaks. They usually do not pay tax on their capital gains, they receive excessive tax relief on interest paid resulting in little or no current tax being paid on their UK profits and the taxation of income attributable to carried interests as capital gains is economically unjustifiable.

As a result it is suggested that the first two tax breaks provide private equity funds with an unfair competitive advantage by lowering their cost of capital and the last provides it with a further unfair competitive advantage by lowering its cost of employing key staff. Each distorts the UK financial markets in ways that are harmful to those markets themselves, the companies that are quoted on them and their ability to secure the capital and management resources to operate for best benefit for the UK as a whole. This is the principle reason for requiring change in the way in which private equity is taxed in addition to the loss of tax and increased social inequality that also justify that change.

Required tax changes are proposed in this paper. First of all it is suggested that income attributable to carried interests be taxed as such under income tax rules. This would eliminate market distortions, reduce abuse of the domicile rules, open the market for management talent, eliminate an unwarranted subsidy of the employment costs of these funds, end the taxation by concession which currently exists in this sector without statutory support and increase social cohesion.

Next it is proposed that explicit thin capitalisation rules be introduced to prevent the abuse of interest payments from the UK to offshore entities to eliminate the charge to UK tax by companies operating in this sector. In addition, it is suggested that tax relief should not be given on interest paid on loans incurred by a UK company that directly or indirectly arose to assist the acquisition of its shares by a third party. This, it is suggested would end the subsidy currently provided by the UK Exchequer to the owners of capital in this sector, would create a level playing field for all types of fund in the financial markets and would reduce the loss of tax in the UK arising from financial manipulation in the private equity market. This also supports company law that suggests this support can be illegal if supplied directly.

Finally a review of tax residence rules and the rules with regard to controlled companies is suggested to develop strategies that prevent the avoidance of the taxation of capital gains arising on the sale of corporate assets located in the UK. This would, again, prevent the effective subsidy provided at present by the UK tax system to the private equity sector, which reduces its cost of capital and provides it with unfair competitive advantage effectively allowing it to acquire quoted companies at undervalue due to the tax relief the private equity sector enjoys.

It has been suggested that to tackle these issues is to risk the private equity market moving out of the UK. This is not true for the following reasons:

a. These activities are already not here for many purposes: they are paying little or no tax so the economic footprint they have here in terms of a return to society is already very low;

b. The companies they want to buy are here, and this will continue to be the case;

c. The support services they need are here and this will continue to be the case.

As such any change is not likely to be detrimental to the UK, the retention of profits here or on tax paid here.

In contrast the upside of the proposed changes is significant:

a. Some, and maybe significant amounts of, tax will be paid;

b. Taxation by concession will be stopped;

c. The UK will no longer be subsiding an activity that does not require state aid;

d. The effective assignment of significant amounts of UK taxation revenue for the benefit of those who are already amongst the wealthiest people in the world will be reduced;

e. Substantial distortions in the UK market for corporate executives will be eliminated, so cutting their rewards, and reducing a cause of significant friction and inequality in society;

f. The cost of capital of private equity companies will be increased, so reducing their competitive advantage. This will mean that:
i. they compete more fairly with existing corporate finance structures which are proven, are accountable and relatively (when compared to offshore) transparent;
ii. stability will be enhanced, which has not been proven to be the case and is inherently unlikely of private equity,
iii. jobs and markets will be protected as a result.

g. The role of the City will be supported in the face of competition from offshore with the inherent threat that poses to the world financial and taxation regulatory environment.

For these reasons the actions proposed in this report are recommended to the Committee.