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.