The U.K. private equity establishment is not amused. The chancellor of the exchequer, our quaintly titled finance minister, created a new 50% tax bracket in his budget for anyone earning more than £150,000 ($219,000) a year. That's 10 pence in the pound more than they pay now on earnings over that level; so it is going to hurt, at least a little bit. Starting in April 2010, that is, when the new rate takes effect. But by then we will likely be weeks from a general election -- and the votes of the wealthy are unlikely to make a huge difference.
Still, it didn't go down well. The chancellor, thundered Simon Walker, chief executive of the British Private Equity and Venture Capital Association, had promised a budget that would invest in the future and play to the country's strengths, while ensuring that Britain remained a world-class center for finance. Instead, he said, Chancellor Alistair Darling had "invested in the past," was undermining the country's strengths and his measures represented "a real threat to Britain's status as a world financial centre."
Well, maybe. People will argue loud and long over whether high earners will leave the country in droves, heading for the not very green hills of polluted Hong Kong or the dreary provincialism of Zurich to save on their taxes. We won't really know the full effect until the markets pick up. That's when all those German and American expat bankers who have lost their jobs and headed home will decide whether it is worth coming all the way back to London for another shift at the gold mine.
What's rather more interesting is that the BVCA boss had almost nothing to say that was not also said by other high earners. For all the public anger at private equity chieftains who loaded portfolio companies with unsustainable debt, the chancellor did virtually nothing to restrict the industry's perceived excesses. While the opposition Conservative Party, traditionally the party of big business and low taxes, has been grandstanding about reducing tax breaks for corporate debt, the government has carefully avoided any such populist attacks on leverage.
Instead, the aim has been to get banks lending again.
Indeed, accountants have pointed to only two or three minor tax changes that will have a big impact on private equity investors, and some of those will either be accompanied by guidance shielding private equity from attacks or largely mitigated by quirks of timing that will allow investors to unwind unfavorable structures before the new rules kick in.
The key issues are the status and taxation of shareholder loans. Under the rules, beginning next April, the interest on any loan to a U.K. company from a foreign unit of the same group will no longer be tax deductible if the loan exceeds the group's bank borrowings. That would not be great for any cash-rich group, although to some extent the removal this summer of a tax on foreign dividends will allow some intra-group loans to be restructured as dividends and lessen the impact of the new regime. But it would undermine the basic rationale for much private equity investment in the U.K., if a general partner, the funds it manages and its portfolio companies were all to be regarded as a single group and the deductibility of tax on the interest paid on shareholder loans were thus to be capped at the level of group debt to external creditors.
Experts say, however, that the BVCA and others have successfully lobbied the government on this, and when the new rules are brought in they will not apply to private equity investors.
Less successful has been the attempt to gain exemption from measures to simplify the rules governing shareholder loans, where the interest is compounded and held over until the sponsor exits the investment. Previously the portfolio company could time the tax deductibility to provide relief only once it started making a profit. Under the new regime, tax relief will have to be taken in the year when the interest accrued and cannot be rolled over. No doubt that will change by the time of the next budget, but for this year at least, the industry will have to live with it.
The new rules will add to the complexity of PE finance and provide plenty of new fees for specialist law firms. But nobody believes these rules will seriously undermine private equity at a time when most worry more about raising the leverage in the first place than about minor changes in taxation on the interest. Britain still supports its buyout shops, even if it does tax their wealthy executives a little more heavily than before.